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By Jason Stipp | 12-13-2011 01:00 PM

No Reason to Doubt Automaker Turnaround

With continued pent-up demand, it's an exciting time for automakers--particularly Detroit's Big Three--and their investors, says Morningstar analyst Dave Whiston.

Jason Stipp: I'm Jason Stipp for Morningstar.

After hitting the skids amid the financial crisis, many automakers are now back on track, but what does the road ahead look like?

Here with me to offer some insights is Morningstar senior equity analyst Dave Whiston. Dave was named one of the Wall Street Journal's Best on the Street analysts earlier this year. Thanks for joining me, Dave.

David Whiston: Thanks, Jason.

Stipp: So we do know that automakers have come a long way from the depths of the downturn. Ford recently reinstated a dividend, which I think is a good sign that they are seeing some stability in their business.

When you look at the automakers at a high level, what do the fundamentals look like to you? How healthy are these companies now?

Whiston: I think it's actually really an exciting time to be an automaker. There is certainly always a lot of volatility and a lot of uncertainty all over the world, but especially when you look at the Detroit Three now, actually, that would be my favorite place to start in terms of health. The Japanese are still also very, very strong, but unfortunately so is the yen, and that's creating a huge problem for Toyota, Honda, and Nissan in particular, but especially Toyota--they are the most exposed to that strong currency impact.

Stipp: So we know some of the automakers have gone through reorganization proceedings, and they have come out seemingly a lot stronger with the better cost structures. Can you talk a little bit about what the profitability is looking like now versus what some of these automakers were seeing in the past?

Whiston: From even just a few years ago, right before Lehman Brothers and the reorganizations and bankruptcy of GM and Chrysler, the profitability picture is just night and day; it's absolutely incredible. And that's why I'm so excited about the future of the Detroit automakers.

Look at GM, right before the recession they broke even with 25% share, and they needed an industry-wide what we call SAAR, or seasonally adjusted annualized selling rate, of 15.5 million vehicles in the United States. Now they only need 18% to 19% share and a SAAR of roughly 10 million units a year.

And 10 million units, by the way, is ridiculously low. Even in '09, which is the bottoming out of this current cycle we're in, we sold 10.4 million vehicles in this country. And just to replace the fleet, you've got to do about 13.2 million vehicles; that's 240 million vehicles on the road times the 5.5% scrappage rate.

So if GM can break even at 10 million vehicles and you need 13.2 million just to even replace the fleet, that's one of the reasons I have been so optimistic about GM printing money. When you look at normalized demand, though, the numbers are even better, because I think it's roughly 16 million to 17 million units a year. 2011 is going to be the fourth consecutive year we're at or below scrappage in the United States, so that trend cannot continue.

Stipp: So I want to talk to you about some of those sales trends, because we have seen improvement, and we've gotten closer to what that average has been, but we haven't hit that yet, correct? What are you looking at for sales for 2011 and sales for 2012? What are your expectations?

Whiston: Well, barring any major severe supply shocks like we've had in Asia twice this year, unfortunately, I think 2012 and 2013 are going to be the years where we're really going to see a lot of positive surprises in the auto industry. And the exciting thing is, I think the absorption of all this pent-up demand, it hasn't really started yet. November was the best month, going back to the SAAR rate, November was the best SAAR in the United States since Cash for Clunkers, and I think that's just the beginning. It was about 13.6 million.

But there is a lot of uncertainty, of course, with Europe, and if in a worst-case scenario, we were to have, say, 10 Lehman Brothers happen in Europe happen at the same time, that's certainly going to impact U.S. consumer confidence, too. So that's the volatility and the uncertainty I alluded to earlier.

Stipp: At some point, though, Dave, don't people have to go out and buy new cars, even if they don't want to. Their cars just wear out, right? Are we are getting to a level of pent-up demand where even if they don't want to put the money up, they might have to start looking for a new car?

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