WHY ARE THOSE AUTO STOCKS SO LOW?

GEORGE CARLIN SAYS HIS CATHOLIC-SCHOOL teachers - when cornered with questions from students about unexplainable aspects of faith - used to say, "Well, it's a mystery."

It's also a mystery why automotive stocks continue to struggle on Wall Street while sales of vehicles and components soar.

The industry's success, and a wealth of other factors are working against it, says Nicholas Lobaccaro, senior auto analyst and senior vice president at Lehman Brothers.

"Clearly we are at the highest we've ever been in selling rate and there's basically no confidence on Wall Street that this is going to continue for a very long time," Mr. Lobaccaro tells the Conference on Automotive Remarketing in Las Vegas.

That creates a dilemma.

Says Mr. Lobaccaro, "A lot of the CEOs are almost hoping for a slowdown in sales because they think that will allow the market to believe that they can still earn money with lower sales and perhaps value them higher.

"We might have to go through a period of slower sales before people are willing to bet on the auto industry again."

I can't imagine a retail, manufacturing or supplier company executive wishing for a downturn, but Mr. Lobaccaro just might be right. There are other factors that are keeping the auto stocks down.

"There is the perception and I'm sure also the reality that we are at the top of the cycle, and you don't want to be a portfolio manager putting all your eggs in the automotive basket," explains Mr. Lobaccaro. "Higher interest rates are very poor for the automotive stocks. They obviously have the potential to slow down demand and they also cause portfolio managers to shift out of an industry like the auto industry."

With unemployment low and the economy growing, he expects two to four interest rate hikes in the near future. "This is not the time that a lot of investors want to step up to the plate and buy auto stocks."

Among the other factors Mr. Lobaccaro cites are that the industry is very mature, brutally competitive and its stocks are considered comparatively slow-growth investments.

He says, "The auto industry might have a trend line growth of .5% while the economy grows 3% or 4%. Some of the industry groups are out-performing this growth way into the double-digit range."

The maturity factor means that the industry's penetration, at least in this and most other developed countries, is quite high. "No one is expecting any great increase in the number of cars per household," notes Mr. Lobaccaro. "And if you're an investor looking at the auto industry, you're frustrated by the long-term supply and demand dynamic of the industry."

One example of the jaded eye with which the stock market looks at the auto industry occurred when AutoXchange was founded. GM, Ford and DaimlerChrysler expect to buy parts, services and supplies through this web-based company. What happened? Oracle's stock went up 20% and GM and Ford's went down.

"Wall Street really has the auto industry in the penalty box," says Mr. Lobaccaro. "When a news item comes out that should have a dramatic positive effect on the auto company and a minor positive effect on their technology provider, the technology provider has gotten all the action."

Auto retailers' stocks, including those of the web-based lead generators, haven't fared well either, for many of the same reasons.

"The retailers have also seen a lot of poor performance," says Mr. Lobaccaro. "AutoNation is probably about 80% off its alltime high of $52.

"Some of the web retailers also have fallen off pretty dramatically as they've had more competition and as the investors begin to scrutinize the prospects of profitability."

Yet another reason why auto stocks are suffering is that the industry often forsakes long-term strategy for short-term benefit.

"The ego of the auto industry drives it more than anything else," says Lincoln Merrihew, an analyst with Standard & Poors and DRI. "GM wants 30% market share. They start putting incentives on SUVs in winter. This does not make sense. Those vehicles should sell themselves. GM will sacrifice short-term profit to get those SUVs in the market."

Mr. Lobaccaro says most auto companies are more focused on being the sales leader than a profits leader.

"Unfortunately in the auto industry, you don't have CEOs who are single-mindedly oriented toward creating shareholder value," he says.

He also says that the reliability on SUVs hurts the industry's overall stock position.

"Something like 17% to 20% of the North American volume is sport/utility vehicles," says Mr. Lobaccaro. "Probably 60%, 70% or 80% of the profitability of the car industry comes from this segment.

"And then you also have a disproportionate amount of profits coming from pickup trucks and minivans. When the analysts look at their crystal ball, all this money is being made in SUVs, and then you look out between now and 2004, we're going to have double the amount of SUVs than are offered now. Obviously if you have twice as many models to choose from and an awful lot more capacity, markets have to go down."

All of these explanations for the poor-performing automotive stocks seem rational. Yet the business is doing so well, it should be paying dividends.

Tim Keenan is senior editor of Ward's Dealer Business. He can be reached at [email protected]