No Respect

By any measure, 1999 was a banner year for the auto industry.

Earnings on the whole were solid. The consolidation trend accelerated with automakers and suppliers buying or furthering partnerships with other players. The manufacturers who drove the 20th century economy moved to scrap many of their outdated processes by leaping headfirst into the next big thing: e-commerce. Interest rates, gasoline prices and unemployment rates smiled on the industry.

Oh yeah, and automakers moved an awful lot of metal in 1999, nearly 17 million units, an all-time record for North American automotive production.

While the industry seemed to revel in a year of successes, one observer was noticeably absent at the party: Wall Street.

It's too simplistic to expect that auto stock values would fluctuate proportionate to vehicle sales. Still, shouldn't a year of record output make automotive stocks even nominally attractive to investors? On the contrary, across the sector, automotive stocks were selling for less than they were at the beginning of the year.

There were, after all, blips on Wall Street's radar screen: Premiums paid in overtime and additional shipping expenses to meet unprecedented demand, the specter of diminished North American market share for domestic producers in the face of foreign competition and no end in sight to profit-cutting incentives.

Lear Corp., the supposed automotive darling of Wall Street, watched its stock price plummet more than 40% after spiking in the spring.

The standout was General Motors Corp., which bucked the trend and managed to drive its share value up in the fourth quarter, partly due to GM's announced partnership with Commerce One to launch a new electronic network with suppliers.

Perhaps more significantly, GM was contemplating selling some of its 68% share of Hughes Electronics Corp., a company racking up millions in losses but viewed longingly for its DirecTV service. Hughes recently sold its aerospace and communications unit to Boeing, a deal that should deposit $2.2 billion (pre-tax) into the GM coffers.

The Hughes question illustrates precisely why auto executives complain that their stocks are undervalued. In another time, perhaps Wall Street would dote on the auto industry after stringing together several good years.

But the age of the Internet has created a new dynamic that turns computer geeks with good ideas into instant billionaires, even if those ideas won't generate profits for years, if ever. Technology stocks rule, and, relatively speaking, the auto industry could churn out 20 million vehicles a year and it wouldn't matter because investors are smitten with a better-looking date.

"The dotcom stuff has got everyone a little crazy," says Michael Suman, a sales and marketing vice president with Johnson Controls Inc. "If you can't invest $100 and get $2,000 back next week, something's wrong with your company."

With this Internet infatuation, it's no wonder the auto industry is falling all over itself to put the Internet in the car, making it an extension of the office at which you already spend too much time.

While the possibilities seem endless for technology stocks, the consensus on Wall Street seems to be that the auto industry did as well as it possibly could in 1999, and that it is destined for one of its famous downturns. And historically, investors tend to buy automotive stocks during recessions at bargain-basement prices.

Which brings us back to the Hughes question and the ludicrous assertion that someone might buy all of GM just to get its share of Hughes, as if the world's largest automaking enterprise could be simply cast aside. Have technology-crazed investors lost their grip on reality, or what? Under this new paradigm, what's good for the country isn't necessarily good for GM.

Removing the defeatist Rodney Danger-field attitude toward automotive on Wall Street is a tall task that has overwhelmed a lot of bright people, including CEOs who gave up and left automotive entirely.

One Harvard MBA who isn't giving up is G. Richard Wagoner Jr., GM's president and chief operating officer. "It does seem that our stock is undervalued," Mr. Wagoner says. "But I bet every person in my position in corporate America feels the same way."

As the year 2000 was beginning, the technology sector was taking a break, while automotive and other manufacturing stocks were actually showing a little life. Some analysts were encouraging investors to buy certain supplier and OEM stocks.

Analyst Jeff Sands says the auto industry has to keep driving for strong earnings, new technology and better production methods, especially if the luster wears off on tech stocks.

"Automotive will still be around because you still need a base of 15 million units a year, says Mr. Sands, of PriceWaterhouseCoopers Securities. "There are still some opportunities in new markets for new growth. People will look at automotive stocks like they do energy stocks - something that has share appreciation over the years."

Still, the cyclicality is hard to swallow for investors, even if the North American-based producers are hoarding cash for a potential downturn. If automakers can weather a recession without blowing all their cash, then perhaps Wall Street will take note.

"Cyclicality and the fear of cyclicality still hangs like a very dark cloud over the auto industry," says analyst David Garrity, vice president at Dresdner Kleinwort Benson.

But Mr. Sands sees it differently. "We are well past the cycles of the past 15 to 20 years," he says. "The industry has been strong since 1992. That's what leaves these guys scratching their heads."

Dwell on it long enough and some truly revolutionary ideas about the future of the auto industry begin to surface.

"We predict that OEMs won't be the same as they are today," Mr. Sands says. "They will be vehicle brand owners, not manufacturers, because the value in manufacturing just isn't there. Customer ownership is there. A carmaker would rather own a customer for life than worry about manufacturing."

A look at net return to shareholders reveals why investors have been cool to automotive.

PriceWaterhouseCoopers studied 42 major suppliers and found that, on average, investors barely broke even if they placed their bets at the beginning of 1999. An investment in the 10 global automakers would have generated a 16% net return to shareholders, which doesn't sound bad until you consider that the Dow was generating returns of 26.7% for the year.

In Wall Street's eyes, it seems a lot easier to punish the auto industry for mistakes than to reward innovation or success.

Like other automaker economists, W. Van Bussmann of DaimlerChrysler Corp. predicts a slight drop in sales compared to the boom of '99, but he sees no big dip on the horizon as far out as 2005. With an outlook like that, why isn't Wall Street more bullish on auto stocks?

"There's a lot of apprehension about sales not being as high as the year before," Mr. Bussmann says. "Chrysler has always suffered more than most for that. (Co-Chairman) Bob Eaton has said he wished there would be a recession, so we could prove that we could continue to operate profitably and pay a dividend."

One executive who has had a tough time on Wall Street is Larry Yost, chairman and chief executive officer of Meritor Automotive, which had been part of the Rockwell group until the automotive operations were spun off in 1997. Its stock began trading around $24 at the time of the initial public offering and was selling for about $18 in late January.

Meanwhile, Mr. Yost has produced some impressive numbers. For nine consecutive quarters since the IPO, Meritor has posted double-digit earnings growth. It finished the quarter Dec. 31 with net income of $46 million, or $0.69 per share, an earnings per share increase of 19% over the same period last year. Meritor's operating margin for the quarter was a respectable 8.3%, up from 3.4% at the time of the IPO in fall 1997.

The company has unloaded marginal or non-core operations, it has a solid book of business for the future, it has a new transmission and clutch partnership with Germany's ZF Friedrichshafen AG and it has committed to buying back $125 million of its stock - all good strategies for shareholder value. But they aren't working.

"What investors are missing is that OEMs and suppliers, especially Mer-itor, are very global companies. It gives us a good balance in our business," Mr. Yost says.

He refers to the heavy truck market, which generates 28% of Meritor's sales. In North America, the market, like the light vehicle sector, had a stellar 1999.

"Everyone is concerned about the heavy truck market dropping off in North America, but demand won't drop more than 10%," Mr. Yost says. If it does, Meritor loses 3% of its sales, but that assumes the unlikely scenario that the company won't win new contracts. Plus, Asia/Pacific is coming back.

"Many investors are well informed about the North American economy and production rates, but they're not as informed as they should be about those markets in the rest of the regions where global suppliers play," he says. "Our financial performance will not be affected one-for-one in North America."

And while supplier consolidation is largely perceived as a good thing, acquisitions also can backfire, especially if they are seen as overpriced.

"In the eyes of investors over the past year, there was concern as to whether there had been adequate due diligence done to ensure that there were adequate returns on the capital employed to make the acquisition," Mr. Garrity says. "Consolidations need to be well-measured and well-executed."

So is the auto industry forever doomed to stand in the tall shadow that the technology sector casts over Wall Street these days? "Not if they use technology to fundamentally alter and improve their business model," Mr. Garrity says.

Oh yeah, the Internet thing.