The Auto Industry
Let me start off by saying that my research into the car industry is some of the most difficult investment research I have ever done. There are so many critical factors affecting the industry and its future right now that it is just flat-out hard to get a grasp on. Since the recession and GM’s old demise, the car industry has rebounded nicely. This chart from macrotrends.net illustrates that rebound nicely:
In addition to the cyclical rebound of the overall global economy, two factors have recently boosted vehicle sales: low gas prices and low interest rates. Low gas prices are particularly helpful to truck makers such as GM and Ford while low interest rates are helpful to any car buyer who needs to finance their vehicle (over 80% of car buyers take out an auto loan). As far as gas prices, I don’t know that anyone really knows what is going to happen. I am not going to try to guess. Interest rates will likely stay “low” for quite some time given a strong dollar and widespread economic sensitivity to interest rate movements; that said, there’s nowhere for interest rates to go but up and this will happen eventually. So let’s say the outlook on gas prices and interest rates are good in the short-term, but likely will not be as favorable 5 years from now.
In addition to these two factors, everyone is talking about “peak auto sales” and whether we have hit it. Basically, car sales have soared since the recession and, historically, this level of auto sales is usually the peak of what the industry can sustain. In other words, despite all the positive factors, it is possible that there simply “cannot” be a greater sustainable demand for buying vehicles than what we already have. If you take a second look at that chart above, you’ll also notice that it sort of looks like we are right at the top of a peak too, but it’s hard to say. My take is that we are probably very close to peak auto sales. After 2016, I think the past growth in car sales is unlikely to continue. If gas prices or interest rates go up, I think a decline is likely.
Now let’s talk about the real threat beyond the wall: the entire model of vehicle ownership may be nearing death. There’s long been a race among the car makers to be the first to build an autonomous car. Companies and individuals have worked toward autonomous cars for many, many years now, but it’s never really been perceived as a threat to the car industry. After all, autonomous cars should just be an added feature for cars like heated seats or power windows. Car makers have no problem producing new features that consumers will buy. However, then came along Uber and Uber changed everything.
Already, people in several cities have ditched car ownership in favor of just Ubering around – but this hasn’t been too much of an issue thus far. The reason? Ubers are expensive relative to car ownership for most people. However, if you pair a ride-sharing service with an autonomous car, you just cut out the overwhelming bulk of the cost in providing a ride – the driver! Without a driver to be paid, ride-sharing services can easily be cheaper than car ownership and I am certainly not the first one to do the math and realize this. That’s why Uber and Lyft have partnerships to explore developing autonomous ride-sharing. They see the future and they know it is very profitable. Whether we get there in 5 years, 10, or 20 – I don’t know – but once we do, wide-spread car ownership will come to an end. The good news for the car industry though, like I mentioned, is that this will be very profitable – for those in the business. General Motors (GM) has partnered with Lyft and Toyota (ADR) has partnered with Uber. Apple (AAPL) and Tesla (TSLA) are likely to enter the market with their own ride-sharing services or an eventual partnership. However, Ford (F) and other car manufacturers should waste no time in building a partnership to protect their future, if it’s not already too late.
So there we have it: an economic recovery, extremely volatile oil prices, artificially low interest rates, peak auto sales, and the casual impending doom of car ownership. Now do you understand why I said this was difficult to get a grasp on? Let’s talk about one company that has made a ride-sharing partnership and that is…
General Motors (GM)
Beyond the industry factors outlined above, let’s talk about a few additional ones affecting GM right now:
- GM has been hitting new overall sales records, however market share in the US has declined. Conversely, it is increasing in China.
- GM has reiterated its EPS projections for the year in spite of concerns of an industry weakening.
- GM purchased an autonomous vehicle company, Cruise Automation, for $1 billion.
- GM purchased about 10% of Lyft for $500 million.
- GM is partnering with Lyft to launch an autonomous ride-sharing beta program soon.
- One of GM’s major suppliers is going through bankruptcy and GM is fighting in court so that it can continue its commerce with the company.
Overall, I am going to slap the same tag on General Motor’s near-term future as I have the industry: I don’t envision much growth past this year. However, I do think GM has positioned itself excellently for the autonomous ride-sharing future. This relieves a very major threat that exists for most other car makers. Beyond ride-sharing, GM has exited its bankruptcy with a different overall strategy that focuses on customer satisfaction and sustainable profits that seems to be working. Let’s delve into GM as an investment.
General Motors stock has relatively steadily declined about 25% since the end of 2013. They are paying out a pretty incredible dividend yield of 5%, which makes them a solid dividend stock in my book. You have to treat dividend stocks a little differently than non-dividend stocks. If the dividend is sustainable and you think the company has a proper valuation, that may be enough for it to be a good deal. You don’t necessarily need high earnings growth in a dividend stock. Additionally, the balance sheet becomes a bit more important with a dividend stock because you have to judge whether you think the dividend is sustainable or could actually grow. In addition to the dividend, GM is buying back billions of dollars worth of the stock. This could act as a hedge against growth concerns and hopefully signals a vote of internal confidence from the company. I do have one problem with all that though and that is the balance sheet.
General Motors has about $25 billion in cash and short-term investments as well as an additional $35 billion in short-term receivables. Conversely, they have about $71 billion in short-term liabilities, mostly comprised of $52 billion in accounts payable. This isn’t particularly positive for me. I like to see a quick and current ratio above 1 always; GM has neither. That said, GM does have enough secured credit that there really isn’t any short-term liquidity issue. But for a company paying such a high-dividend, making high-price acquisitions, and buying back stock – I wonder if GM is managing its cash poorly. I am concerned the dividends and stock buybacks are going to have to be drawn back when we finally declare we’ve reached peak auto sales. In addition, though I would support GM increasing its investment into Lyft, it would obviously come at a cost.
While I can generally get behind analysts’ predicted growth in General Motors, I don’t see enough support for the 2019 growth figure. As a result, I am going assume a modest 1% growth for the last two years and average it all for an annual growth rate of 2.5% – significantly lower than the analyst 5-year rate. That said, GM does typically outperform analyst expectations. If you run GM’s EPS and my predicted growth rate through MoneyChimp’s EPS DCF Calculator as I previously discussed, you’ll get a per share valuation of about $73, an incredible 138% return that would take GM stock higher than it’s ever been (since bankruptcy). If you use the analyst-predicted 9.39% growth rate, you’ll get a valuation of $96, a 213% return. Now before you lose your mind, there is something very important to understand – the market does not always value stocks… at value. The market often applies significant discounts or premiums to industries or individual companies. In this case, the whole auto industry is currently being priced at a big discount and GM is being priced at significant negative growth.
In addition to the EPS DCF valuation, the cheapness of GM is confirmed by a 4.60 P/E ratio (7.40 average for the industry) and a price to book ratio of only 1.15 (about the same as the industry). Because the discount is industry-wide and seems to have been around for a while, I can’t realistically set a price target of $73 for GM. However, what I can say is that I believe it is fundamentally a very cheap stock, which should help mitigate downside risk and maximize upside potential depending on future news.
There are several very real risks to General Motors and the auto industry as a whole. That said, I think GM has positioned itself well so that it can avoid the bigger of those risks, namely the autonomous revolution. In fact, they may the best prepared car maker. I think their overall strategy and focus after their turnaround warrants a lower discount than is being applied to the rest of the industry. Even assuming a pretty poor future after this year, GM stock is very cheap. While I am concerned the dividend may not be sustainable, it is one of the best dividend stock opportunities out there. It meets everything I would want in a dividend stock except a less-than-stellar balance sheet. As a result, I rate General Motors a long-term buy as a dividend stock. If the dividend changes, that would have a major impact on my feelings toward the stock. I can’t in good faith set a price-target for the stock, however I would certainly consider selling if the price ever reached its intrinsic valuation.
Disclosure: I own shares of General Motors (GM). I am not a financial advisor. Do not make any investing decision solely based upon what you read here. It’s your money, invest it wisely.