The US auto market has been tumultuous over the past couple of years. The events of 2020 initially caused a significant decrease in vehicle demand, but also caused an even more substantial and lasting decrease in vehicle production and production. of crucial vehicle inputs (ie, semiconductors). As many American vehicles were old and interest rates were low, demand for cars improved in late 2020 into 2021, creating a substantial shortage that drove new vehicle prices up tremendously.
Despite record increases in new vehicle prices, leading manufacturers such as General Motors (NYSE:GM) did not retain large profits. The company’s stock initially rose through 2020 until the middle of last year, but has since fallen back to 2019 levels. GM is now back in the $30-$40 price range it was stuck in from 2013 to 2019 .Despite this, the company is posting above-trend cash flows and gross earnings per share. See below:
General Motors’ rating is weighed by various factors influencing today’s auto market. High new vehicle prices have boosted the company’s gross margins considerably, but now that critical bottlenecks have ended, many anticipate a reversal of the price impact. Additionally, the vehicle shortage has caused total US vehicle sales to drop dramatically and remain at low levels. Total US auto production begins to rise. However, many manufacturers see inventory rates rising as the slowing U.S. economy and rising interest rates likely weigh on demand for expensive durable goods.
GM currently trades at a very low P/E of 5.5X and is expected to raise its dividend back to normal levels over the next year as long as the outlook continues to normalize. The stock is trading at an apparent discount, especially compared to electric vehicle giant Tesla (TSLA). Although Tesla still produces many more electric vehicles, GM is ramping up its electric vehicle production and has an extensive global supply chain that allows it to scale efficiently, improving its competitive potential for electric vehicles. With this factor in mind, it may appear that GM is a solid long opportunity today. That said, shifting economic winds could drag the entire U.S. vehicle market down to the detriment of GM’s EV expansion goals.
Car sales likely to remain low as rates rise
Unlike housing, the vehicle market has become extremely unaffordable now that prices and interest rates are both high at the same time, causing monthly payments on new car loans to average around $748 per month in October, rising from ~$540 in 2019. Even without further rate hikes (which are likely), auto loan rates are virtually certain to rise significantly over the future as lenders face higher deposit borrowing costs (as CD rates and savings account of most banks adjust slowly to Treasury rates). In addition, falling real wages, low personal savings and weak consumer confidence all point to declining demand for large purchases.
First, US vehicle sales and production are both weak today. Production is increasing, but sales aren’t growing as fast, raising the potential for new vehicle prices to fall or stagnate. See below:
New vehicle prices have risen rapidly over the past two years amid a huge shortage of vehicles. The latest measure of the ratio of total US domestic auto inventory to sales is slightly out, but was still very low, although it has reversed as production has improved. Comparatively, consumer sentiment remains near record lows, while overall growth in U.S. commercial bank auto loans has stagnated. See below.
Looking at the short term, it appears that the US auto market is still in a deficit. However, with loan growth sluggish amid weak consumer sentiment (and spending power), the deficit may quickly become a glut as vehicle production picks up. I expect this to happen by the end of next year as car sales remain low or even decline due to rising rates and weakening spending power combined with increased vehicle production.
GM, Ford ( F ), Honda ( HMC ), Toyota ( TM ), Tesla ( TSLA ), and other peers have lost considerable value over the past ~18 months despite overall increases in cash flows (excluding Ford). Much of this stems from the fact that the economic outlook for the industry has generally declined. First, from significant declines in sales due to lack of parts. More recently, from the negative outlook for sustainable consumer discretionary demand – driven primarily by higher consumer interest rates and declining consumer spending power. In my view, the latter is a significant factor that will likely influence the earnings and cash flow of all these firms over the next two years.
General Motors takes on Tesla
General Motors may lose some sales and cash flow over the next couple of years, but its valuation is low enough that it isn’t necessarily likely to fall in value. As long as the losses are not too extreme, the economic slowdown seems somewhat priced into the stock. Of course, like its peers, GM does not have a strong balance sheet and is highly exposed to an economic downturn. It ranks slightly higher in debt-to-equity with a lower quick ratio than its peers. That said, all peer groups generally have poor balance sheet health. See below:
Vehicle companies often operate with a leveraged balance sheet because they use debt to grow and finance vehicle components. American giants Ford and GM are running on significantly more debt than Asia’s Honda and Toyota. All are running at quick ratios around 1X, indicating they have as much short-term assets as needed (excluding inventory) to pay off short-term liabilities. However, if inventory levels continue to rise, as shown by increasing levels of “stock days outstanding,” all may face some degree of liquidity strain.
Compared to peers, General Motors has a slightly lower “EV/EBITDA” ratio of 6X, roughly the long-term industry average. Honda and Ford have higher valuations, potentially due to their considerably higher dividend yields. Instead of restoring its dividend, General Motors has focused on keeping capital spending high to build a more substantial supply chain for electric vehicles. See below:
Ford EV is focused on the shorter term, focusing on creating an initial model with relatively low initial costs. By comparison, General Motors is playing the “long game” by building a dedicated EV architecture, including being the only automaker other than Tesla to produce its own battery cells. The market is changing, but General Motors appears to offer more long-term value in its approach. Its investments today should create lower production costs for electric vehicles and potentially superior products 3-7 years from today.
Comparing General Motors or Ford to Tesla adds layers of complexity. Both are growing their electric vehicle market share, and General Motors is poised to dramatically accelerate its electric vehicle platform in the coming years. TSLA trades at a a lot “EV/EBITDA” higher than 35 times, almost 6 times of its competitors. Tesla is by far the dominant player in electric vehicles, but that may not last as its Capex-to-sales ratio is now just 9.5%, below GM’s and well below older levels of 20-60%. This data indicates that Tesla is becoming less focused on long-term growth, while General Motors is. Primarily due to stock sales at extreme valuations, Tesla has a much stronger debt-to-equity ratio of just 5.7%. Still, it seems clear that either TSLA is overvalued or GM is undervalued based on the convergence of their business models.
General Motors is a relatively difficult stock to value because there are various bullish and bearish factors facing the firm. Looking ahead 3-12 months, I am mildly bearish due to strong evidence that vehicle sales and new vehicle prices will decline in 2023 amid negative economic trends. However, General Motors does not appear overvalued compared to its peer group directly, and may be slightly undervalued due to a “dividend premium” for its dividend-paying partners. General Motors may also benefit from raising dividends to normal levels; has the ability to do that, but I believe long term investors will benefit more from GM making more significant investments in EVs instead of dividends.
Looking at GM over the long term, the stock looks undervalued and likely to deliver decent returns. It presents mild balance sheet risks that could arise if the downward economic trend becomes too extreme. However, looking beyond this period, I believe GM has excellent growth potential due to vertically integrated Investing in EVs. Ford and most of GM’s other peers aren’t as focused on vertical integration in the EV market, which makes GM a much more robust long-term growth investment for EVs. Tesla, in my opinion, is a terrible EV investment today due to its extremely high valuation combined with a sharp drop in capital investment.
If I were to price GM like Tesla, then GM would be trading 4-6X more than it is today. Of course, Tesla looks significantly overvalued based on its declining growth, even after its share price declines. Accordingly, GM’s “enough EV” is likely closer to 2-3X, given that Tesla’s valuation is not necessarily based on a realistic outlook for future, discounted cash flow. That said, the economic situation may cause General Motors and all peers (including Tesla) to see the outlook temporarily decline. Overall, I am neutral on GM for now, but may look to buy the stock as a long-term investment at a lower price in the future.