Description

Our thesis is:

• Driven by increased profits from new models of trucks and by share repurchases, EPS will increase from about $6.40 to $8.50 plus in 2020 (assumes a normal year for industry car sales).
• Importantly, GM is much more of a truck company (pick-up trucks, vans, and large body-on-frame SUVs) than a car company (in 2020, we project that the truck segment, will contribute about $5.40 per share to GM’s EPS).
• Whereas the car business is a highly competitive business with an uncertain future, the truck business is a very good business with a very good future; car businesses deserve to sell at low multiples of earnings -- truck businesses at much higher multiples.
• Given the fundamentals and values of GM’s truck business, GM’s shares are materially undervalued, even if the company does not succeed in its aggressive efforts to develop industry leading electric cars and autonomous cars.
• And, if GM is successful with its electric car and autonomous car efforts, the company’s technological successes may result in GM’s shares selling at a relatively high multiple of earnings.

GM’s Trucks

In the 1960s, German farmers complained about the amount of low cost chickens and chicken parts being exported into Germany by efficient American farmers.  Responding to the complaints, the German government placed a 25% tariff on the imports of chickens and chicken parts – and the American government then responded by placing a 25% tariff of the import of trucks from all countries on the world (Canada and Mexico were exempted later).  This tax on trucks remains today and is known as the Chicken Tax.  The Chicken Tax is one reason why the U.S. pick-up truck business is a good business.

But, there is another apparent reason.   There is strong brand loyalty among owners of pick-up trucks.  This loyalty makes it difficult for new entrants to break into the market.  Toyota (with its Tundra model) and Nissan entered the market but failed to make large inroads – and now suffer from lack of scale vs. GM and Ford. 

Ford, with its F-150 has been the brand leader in the full-sized pick-up truck market with a recent market share of about 38%.  GM is number two in the market with recent market share of about 35%.  GM lost share last year after Ford announced its updated full-size models, but GM might regain the share next year after launching materially updated models this year.  I note that, because the high brand loyalty among owners of pick-up trucks, it is unlikely market shares will change much, except temporarily during periods when one of the competitors launches a newly designed model.

Given the protection from foreign competition and the brand loyalty, the pick-up truck business has been highly profitable for Ford and GM.  We estimate that Ford’s profit margins in its truck segment are about 15% and that GM’s are not much lower now, and could be 15% next year after the new models are fully launched. 

Last year, GM sold about 1.58 million trucks, vans, and very large SUVs in North America.  Because of manufacturing downtime due to the new models launches, sales likely will be moderately below 1.58 million this year.  However, we would expect that the new models will lead to some market share gains in 2019 and 2020 (GM lost some market share in 2017).  Our best guess is that, in 2020, GM will sell about 1.625 million trucks (includes vans and large SUVs) at an average price of $43,000 each and at an average pre-tax margin of 15%.  I note that the demand for pick-up and other trucks should be favorable given the outlook for the residential construction industry.  If our projections prove true, GM would earn $10.5 billion pre-tax from its truck segment before any allocation of corporate and interest expenses, or about $9.1 billion after allocating 50% of corporate and interest expenses to the segment.  After taxes at a 26% effective rate, a $9.1 billion contribution to earnings works out to about $5.40 per share (based on a projected diluted share count of 1.25 billion). Further, given the fundamentals of the truck business (and especially the brand loyalty), we would value the segment at about 15 X earnings – and therefore conclude that the truck segment alone is worth about $80 per GM share.  This is why we conclude that GM is much more of a truck company that a car company – and why GM’s shares currently are selling at a bargain price.

Realizing that one should never ask his barber if he needs a haircut, the following are quotes by GM’s management on the company’s truck business:  

• The truck business is a $65 billion very high margin business. If you look at the midsize pickup segment, a segment that was essentially abandoned a few years back, we came in and reinvented that segment with the Chevrolet Colorado and the GMC Canyon and we have grown an entirely new business in this segment alone. So, we are going to continue to focus on the truck business and the growth opportunities.
• We are just getting ready to launch our all new architecture trucks across the entire line of light duties, heavy duty full-size pickups, and full-size SUV, which is going to generate strong returns for years to come.
• To expand on the truck and full-size SUV franchise. This is not like the traditional auto businesses where we compete around the world. It is a segment that is very resilient. It has high customer loyalty. It has fewer competitors. And, it has a great margin profile -- in fact, double-digit margins. And for us specifically, those margins have grown through the lifecycle of the K2 platform.  So, strong margins and improving margins throughout the life cycle. And importantly, we have a very strong position both in full-size trucks and a dominant position in full-size SUVs.
• When we look at the truck market, we think of three segments, high-value, high-volume and high-feature. Now the high value is ATPs below $35,000, high volume is between $35,000 and $55,000, and high feature is above $55,000.  Our overall total segment share is 35%. We are doing better in the middle of the market, but we have opportunity on each end. And that is why, as we looked at our truck franchise, both the Chevrolet and the GMC entries, we really looked at how are we going to make sure we are well-positioned across all three segments to make sure that we can expand our business overall and also much improve our ATPs.

GM’s Cars

The car (and normal SUV) business is highly competitive in most parts of the world.  It is a fair-poor business.  Furthermore, given the likely transition to EVs and AVs, the businesses’ intermediate term future is uncertain.  It is difficult to predict which of the car manufacturers in the world will be winners and which will be losers.

GM sold about .85 million cars and 1.15 million SUV’s in North America and another 1.98 million vehicles outside North America. In recent years, to the credit of management, the company has been emphasizing SUVs over cars and has been exiting manufacturing and marketing in countries where it is poorly positioned (for example, it sold its Opel business in Europe).  Also, GM is in the final stages of a $6.5 billion cost reduction program – and management has stated that more cost cutting is likely after the program is completed at the end of this year.  As a result of management’s efforts to make do in a tough business, we project that in a normal year, GM’s North American SUV business will earn mid-single digit margins, its North American car business will earn low-single digit margins, and its non-North American wholly owned businesses will earn very small profits after having been unprofitable in recent years. In addition, the company has joint ventures in China which have been highly profitable and which contributed about $2.1 billion ($1.40 per share) to GM’s net profits in 2017.

Looking ahead to 2020, we project that GM’s wholly owned car and SUV businesses will contribute only about $.80 per share to GM’s profits, after allocating about 50% ($1.4 billion) of the company’s corporate and interest expenses to the businesses. We further estimate that the joint ventures in China will contribute about $1.70 per share to GM’s earnings (up modestly, solely due to a projected decline in GM’s share count).  

In terms of valuations, we would place a low PE ratio on the wholly owned car and SUV businesses (maybe 5-7 X earnings) and, because of the risks of doing business in China, also a low multiple on the Chinese earnings (maybe 8-10 X earnings).  Thus, all of GM’s non-truck manufacturing businesses are valued at only about $18-23 per GM share.

GM Financial

After basically exiting the auto financing business (consumer car loans, consumer car leases, and dealer loans) a number of years ago, GM recently has been aggressively growing its financial subsidiaries.   The subsidiaries’ operating profits totaled $1.20 billion last year vs. $.76 billion in 2016 – and are projected (by the company) to grow to $1.50-2.00 billion in the near future.  We  project that GM Financial will earn about $1.8 billion in 2020, or about $1.05 per GM shares (after taxes at a 26% rate and based on 1.25 million shares outstanding).  We would value the business at 7-8 X earnings, or at roughly $8 per GM share.

Automobile finance companies incur risks of bad loans and declining residual values, but we believe GM Financial is being managed conservatively – and its scale is such that it presents a relatively small risk to the overall health of its parent company.

Corporate Expenses and Large Expenses to Develop EVs and AVs

GM has normal corporate expenses, plus, at this time, large annual expenses to develop EVs and AVs.  I project that these corporate and development expenses will total about $2.5 billion in 2020, or about $1.55 per share.

Importantly, by all reputation, GM is among the leaders in the development and future mass commercialization of EVs and AVs.  When describing its EV technology, management has claimed:

• If you look at General Motors' history and our switch from lead acid to nickel metal hydride and you look at some of the chemistry that we own today (we have a competitive advantage). We own the chemistry, and that is a very important piece of this.
• We believe we lead the industry in battery cell cost per kilowatt-hour. (At the last conference), we talked about $145 per kilowatt-hour.  We still see that going underneath $100 per kilowatt-hour, and we are well on our way to do that. This is a big deal because if you look at the pack cost, 70-75% of the electric vehicle itself is the cost around that battery pack. And so that is really the key to unlock what we are talking about here today.
• We will launch at least 20 all-electric vehicle (models) by 2023. 

And, with respect to GM’s Cruise AV program, management says: 

• We have 180 Cruise test vehicles built.  We are on a path towards being able to do up to 1 million miles a month of on-road testing in 2018. And the scale of our on-road testing will increase exponentially just like our performance of the vehicles will increase exponentially and proportionately as we approach commercial deployments.

Balance Sheet and Finance

GM has about $6 billion of net cash (excluding GM Finance), $23 billion of deferred tax assets, $9 billion invested in unconsolidated subsidiaries, $10 billion invested in its financial subsidiaries, and $21 billion of pension liabilities.  We note that stated pension liabilities should decline sharply when interest rates fully normalize.  The large deferred tax asset means that GM’s cash taxes should be low for the next several years.  Based on these metrics, one can conclude that GM’s balance sheet is relatively strong.

GM has been spending heavily to bring out its new line of trucks and to develop its EV and AV programs.  Capital expenditure have been running at about $8.5 billion per year (or $2.0-2.5 billion more than DD&A) and the company has been expensing about $1 billion per year to develop its technology for EV and AV.  Because of these high expenditures, the company’s automotive free cash flow has been running at about a $5 billion annual rate, or not much more than 50% of non-GAAP net earnings.  Looking ahead, capital expenditures should decrease by 2020 and net income should increase, with the result that the company’s free cash flow should increase sharply – maybe to $8+ billion per year.

  For the past two plus years, management has been holding GM’s dividend flat at $1.52 per share ($2.1 billion per year) and using the rest of the company’s free cash flow to repurchase shares.  As a result, the company’s diluted share count has declined from 1.64 billion shares in 2015 to 1.49 billion in 2017 and a projected 1.40 billion this year.  We project that the diluted count will decline further to about 1.25 billion shares in 2020.  If so, the share count will have declined by 24% during the 5-year period, causing a corresponding increase in EPS and shareholder values.

2020 EPS Projection and Valuation

The following is my estimate of how 2020 EPS will breakdown by line of business:

North American trucks             $5.40 per share 60%

All other wholly owned vehicles                 .80   9

After tax interest in Chinese JVs               1.70  19

GM Financial               1.05  12

Total                       8.95         100

With the truck business worth about 15 X earnings and with the other businesses worth 7-8 X earnings, the total value of GM in 2020 would be more than $100 per share.

We note that the company seems optimistic that it can achieve its stated goal of a 10% EBIT margin on its core business.  A management quote is:

• “We are committed and continually focused on cost efficiencies - and that has allowed us in part to deliver the record financial results that we posted year-over-year -- and we are making great progress toward our stated goal to achieve 10% margins in our core business.”

We project that GM’s revenues in 2020 will be about $163 billion.  A 10% margin on $163 billion would be EBIT profits of $16.3 billion on the core business. We need to subtract about $1 billion of non-core expenses (for the EV and AV development efforts) from the $16.3 and we need to subtract close to $.4 billion for interest expense and minority interests.  For the purposes of this calculation, we use a 22% effective tax rate, which treats the Chinese JV net income above the line (the 26% tax rate used to calculate segment net earnings is the effective tax rate with the Chinese JV net income below the line).  Working out the arithmetic, management’s 10% goal works out to net income of $11.6 billion, or $9.25 per share.

Importantly, GM’s share price has lagged over the past several years:

2010-2012 low 19 high 39 avg 29

2013-2015        26         42        33

2016-2018        26         47        36½

The apparent reason for the lag is that investors generally are concerned that the North American car market is at a peak and that the future of the automobile is uncertain.  We believe that investors incorrectly place too much weight on GM’s car business and insufficient weight on its truck business. Furthermore, investors do not give GM sufficient credit for the success of its cost efficiency program, for its efforts to develop EVs and AVs, or for the quality of its management.  Also, in our opinion, GM’s shares are not being given sufficient credit for the relatively favorable outlook for the truck market and for GM’s ability to gain market share though the introduction of newly designed products:

• As you look at our portfolio, we are really in the middle of an overall new product portfolio cadence. This is the richest product portfolio renewal in the recent history of General Motors. If we look back in 2015 and 2016, we turned over our global passenger car portfolio. In the last two years, we have been launching all new crossovers across the portfolio.  And the architectures we have launched to-date, and those coming, are designed to be used for more than one cycle – and this includes our full-size trucks. So, this allows us to be very efficient from a capital perspective -- and it will take us into the future in a very strong fashion of capital utilization

Catalyst

attractive valuation and company is recognized more as a truck company than a car company.