Recession fears took a toll on the stock market for another day Friday, and automotive stocks in particular were taking it on the chin, with Ford: (F: -3.60%) and: General: Motors: (GM: -5.08%) down 5.8% and 6.3%, respectively, at 2:30 pm ET. Electric car stocks aren’t immune to the selling, with: Lucid Group: (LCID: -1.96%) down 3.6%%.
On the plus side, shares of electric-truck maker Rivian: (RIVN: 0.69%)which fell right alongside the legacy automakers earlier in the day, were down less than 1% at 2:30.
The big-picture reason car stocks are down today concerns the economy. For instance, rising inflation and central banks’ efforts to curb it by raising interest rates has a: Wall Street Journal reporter noting that “the higher the Fed raises rates, the greater the risk that it will go too far, tipping the economy into a recession.”
That obviously wouldn’t be good news for car stocks, for more than one reason. A recession means economic hard times that deprive consumers of spending power, such that they may be less inclined to buy new cars. Also, rising interest rates make it more expensive for consumers to afford cars and for automakers to service their debts.
Meanwhile, adding to carmakers’ troubles, Ford warned investors earlier this week that its supply chain is still a mess, and that likely means that’s the case for peers, too. Ford said it expects to have 40,000 to 45,000 cars at the end of the third quarter that it cannot finish building (or sell) due to a lack of the necessary parts. Additionally, Ford management complained that the parts it can get hold of are costing more in this inflationary environment, adding as much as $1 billion to its input costs. That would subtract $1 billion from its profits, unless it manages to pass those costs on to consumers.
This all adds up to a rather bleak picture for automakers, who are at risk of seeing their profit margins squeezed at both ends as the economy weakens. On the one hand, their costs are going up because of parts inflation and the higher cost of debt. Ford’s balance sheet shows more than $102 billion in net debt, and GM’s is not much better off with $90.6 billion more debt than cash on its books. On the other hand, sales could be impacted as consumers have less to spend.
Granted, Rivian and Lucid look somewhat healthier, with more cash than debt on their balance sheets. But neither of those new automakers is profitable yet, and their cash is constantly shrinking.
It’s for this reason — dwindling cash hoards and nonexistent profit margins — that I still lean away from endorsing Rivian or Lucid over Ford and GM. At valuations of just seven times trailing earnings (Ford), and five times (GM), I still believe the major automakers offer the best prospects of profit for investors as the economy heads into recession.
And in the near term, at least, I’m leaning more towards Ford over GM, primarily because the former is free-cash-flow positive, and the latter isn’t.
Rich Smith has no position in any of the stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.