Spread widening is likely to continue for the Big Three automakers after Moody's Investors Service's recent downgrade of General Motors, according to a portfolio manager and a sell-side analyst. However, they suggest that such widening will ultimately lead to a buying opportunity, and argue that the industry's current difficulties will not lead to the "Extinction of the Car Giants," which was the title of a recent cover story in The Economist magazine.
Fifth Third Investment Advisors has a below market weighting to the U.S. auto sector, but will look to add to five-year issues from GM and Ford Motor Co. if spreads widen in the third quarter beyond the 350-400 mark, says Mitch Stapley, portfolio manager at the Grand Rapids, Mich. firm. Five-year spreads on Ford's 6 1/2% notes of '07 (A3/BBB) were 275 basis points over Treasuries last Thursday. GM's 5 1/8% notes of '08(Baa1/BBB) were 278 basis points over the curve. Stapley thinks any number of factors, including as a breakdown in union negotiations, or pension issues stemming from a continued decline in long-term interest rates could cause spreads to blow out once again. Still, he says extreme pessimism is unwarranted. "They have a lot of financial flexibility and a lot of cash. To be peeling the death knell for the industry is probably premature," he says.
Slowing sales could also lead to concerns about credit quality near term, warns John Kollar, analyst at HSBC Securities. Kollar has a near-term "reduce" on the sector, though he declines to name a target spread level. Still, he remains bullish long-term, citing the companies' improved productivity and positive demographic trends.