US old economy firms come under the spotlight

The US earnings season continued apace with a week of announcements from 'new economy' companies that have become a favourite among investors – Amazon, Facebook/Meta, Apple, Microsoft, et al. However, as the season progresses it is obvious that more established companies are putting in strong enough results to raise questions as to where the true value currently lies in the US market, with some of the metal bashers mass producing cars in a way that Tesla can currently only dream about.

The hulks of Detroit

The main corporate exercise for senior managers at General Motors (US:GM) and Ford (US:F) is checking over their shoulders to see whether a hostile all-share funded bid is about to come from Tesla. The combined market capitalisation of the Detroit-based carmakers at $151bn (£111bn) is just 13 per cent of the value the market assigns to Tesla, which means that Elon Musk could fund a takeover of both with a modest portion of his paper wealth. The historic lowliness of the valuation, in a market that has had a tremendous bull run, reflects the prevailing view that the technology that powered the 20th century is rapidly running out of road as we travel towards the world of mass-market electric vehicles and hydrogen fuel cells.

But even taking into consideration the worst-case scenario that traditional car makers are unable to change their business models, this is only one way to measure a company like Ford, which is arguably the most adroit of the Detroit car makers, producing at least 1m cars a quarter. To put that into valuation terms, at a forward forecast price/earnings (PE) ratio of nine, Ford is valued at just half of its three-year average PE ratio of 18 – this for a company that produced a quarterly pre-tax profit of $1.9bn. Ford, like other car manufacturers, experienced some margin contraction during the period due to ongoing shortages of semiconductors restricting manufacturing capacity, most notably in its European division, but chip availability has improved and its low historic rating is interesting from a value investor’s perspective. One for the watchlist.   

If management competence were a prerequisite for corporate survival, then General Motors should have deservedly given up the ghost well before its taxpayer-funded bailout in 2009. The company spent years making one bad decision after another before these finally added up to one of the biggest corporate bankruptcies of all time. A prime example is the little-known fact is that GM pioneered the first mass-market useable electric car in 1990s called the EV1. Unfortunately, with oil hovering at barely $20 a barrel at the time, gas-guzzling sport utility vehicles were all the rage – which The Simpsons’ lampooned in one episode as the “Canyonero: unexplained fires are a matter for the courts!” GM eventually recalled the several hundred EV1s it had lent out on lease agreements and, in its infinite wisdom, had them crushed. As if to make amends for that decision, GM and its Chinese joint-venture partner SAIC have now developed a cheaper, mass-market electric car.

It is interesting that GM’s shares trade at a slight discount to Ford at an average PE ratio of 8.4, in the sense this is broadly in line with its longer-term average, whereas Ford seems to have fallen further in the market’s estimation, which opens the possibility that Ford has more contrarian value if the market has overreacted by marking down its shares too harshly.

Metal-bashers and equipment makers are not everyone’s idea of a modern investment, but Caterpillar (US:CAT) is a still a key bellwether company for the US economy. The heavy equipment maker showed signs in the quarter that its operational gearing was starting to go into overdrive, which helped it to absorb higher costs. Third-quarter sales were up by 27 per cent to $11.7bn, with higher freight and labour costs showing up in its cost of goods sold, which was $1.7bn higher at $8.6bn. Although the share ratings remain at a consensus PE ratio of 20, the PEG ratio is edging towards 0.6 – anything below 0.5 would count as value by this measure – and Caterpillar could be one to watch for a better buying-in point.

Food and Fizz

Whatever life was like for the rest of us over the past few years, it was certainly never dull at Kraft Heinz (US:KHC). Earlier this year it agreed to pay fines totalling $62m to the Securities and Exchange Commission to settle claims that it had manipulated its accounts between 2015 and 2018 in the run-up to the controversial merger with Heinz – the motive for which was to improve Kraft’s cost ratios.

The extra frisson with the company is that 26 per cent of it is owned by Warren Buffett’s Berkshire Hathaway investment company. Buffett, known as the Sage of Omaha, has so far maintained his public commitment to owning the shares, with the proviso that he believes the company needs to start paying down debt. There were signs in the quarterly results that it is making good on a promise to deleverage – the carrying value of its debt in the quarter was $24bn, down from $28bn at the last year-end.

Overall, there were clear signs in the cash-flow statement that management is trying to improve the cash position. For example, cash outflow to cover inventories fell by 40 per cent to $264m, compared with this time last year. In fact, there has been a consistently higher cash-flow yield coming through in recent results, which suggests that the synergies between Kraft and Heinz that were the base case for the merger might finally be bearing fruit.

The NAV to price ratio of 0.9, according to Refinitiv data, puts KH at an attractive discount to many of its stock market peers. The consensus PE ratio of 13.8 is slightly above its three-year average and, as long as Buffett stays put as an investor, the shares have a value attraction.

Coca-Cola (US:KO) is another of Berkshire Hathaway’s favoured investments, although its overall stake is below 10 per cent. Coca-Cola’s main asset is its instantly recognisable and difficult to replicate brand that puts a wide economic moat around its operations – so long as Americana remains fashionable. Overall, the third quarter was largely routine; operating profits came in $600m higher at $2.9bn and the company completed a post-period acquisition of sports drink maker BodyArmour – paying $5.6bn for the 85 per cent of the company it did not already own.

Unsurprisingly, with a cash conversion rate of over 100 per cent and a return on capital employed that has averaged 16 per cent a year, in terms of business profile Coke represents a slightly more infrastructure-heavy version of the tech companies that have propelled the US indices higher over the past 18 months. As such, it can only really qualify as a share that occasionally offers good relative value and, with a PEG ratio of over 1.6 and an average PE ratio of 24, it might be better to wait for a better buy-in price.

The main impression of the third-quarter season was that as long as investors avoid overpaying for the highly rated tech shares, and don’t track the index in a way that makes them shareholders by proxy, then there are pockets of potential value to be found. It is a useful reminder that stock picking is still a strategy to be respected even when times are good and all the boats are floating on the tide.

We will have more on the US market in a forthcoming cover feature.