General Motors – Value Trap?

GM headline

General Motors appears to be a sound investment. It has a 4.7% dividend yield and looks to be reasonably priced. The company manufactures Chevrolet, Buick, and Cadillac brands but could be facing a shift in consumer behavior. GM has made a big bet on China and has struggled thus far. Actually, the only market the company has done well in is the U.S. GM is a global brand that has been challenged outside of the U.S over the last five years.

Markets and Market Share


GM has four automotive geographic segments; North America, Europe, International Operations, and South America. The International Operations segment is primarily made up of China. About 72% of GM’s sales come from the U.S. However, the company is investing in boosting sales outside of the U.S. Europe accounts for 13% of sales followed by International Operations with 8% and South America with 5%.

The only segment that has seen moderate growth is the North America with 5.4% sales growth. The other segments saw steep double digit declines in 2015. International Operations declined 12.3%, Europe 15.9%, and South America saw a massive 40% dip in sales. Overall, automotive sales shrank 3.4% in 2015. This followed a lackluster 0.7% decrease in 2014 automotive sales.

Market share trends are also worrisome for investors. In nearly every market, GM is losing market share. The only market that saw increased market share was China which grew a mere 0.2%. In the current environment, GM is struggling and things might become more difficult with increased competition going forward.

Margins – Reversion To The Mean


GM has seen a trend of decreasing margins over the last six years.

GM Profit

The average profit margin over the last six years is about 10%. In 2015, GM’s boost in margins came from $11.3 billion in favorable “Other” cost variances. These favorable variances include a $6.9 billion net foreign currency effect. Without this $6.9 billion, the profit margin would have been a disappointing 7.3%. I would expect the profit margin around 7-8% in a normalized operating environment. However, the company’s 2016 guidance would infer they believe the Dollar will remain strong so the favorable foreign currency cost variances will continue to keep costs down and margins up. When this variance normalizes, earnings will decline and suddenly the company will not appear to be as cheap as it appears today. The company has identified $3.5 billion in cost efficiencies it hopes to achieve by 2018. If they are successful, it will help insulate them from the reversal of temporary favorable cost variances.

Competition And The Future of Cars


Competition in the automobile industry is heating up.

GM Competition

The interesting thing about this slide is it doesn’t mention GM’s traditional competitors like Ford (NYSE:F), Toyota (NYSE:TM), and Chrysler. The automobile industry is being disrupted by technology companies. GM recently invested $500 million in ride-sharing company Lyft in an attempt to gain exposure to the shifting market. Technology companies have been working on autonomous vehicles for several years. GM announced two months ago that they now have an autonomous vehicle department. They have given tech companies with better talent a three or four year head-start. Not good.

According to a study from the University of Michigan, only 77 percent of Americans held a driver’s license in 2014. That represents a five percent drop since 2008 and a ten percent drop since 1983. Although all age groups recorded losses in relation to license holders in 1983, among the youngest group the losses were continuous, without upturns in intervening years. If you would like to read the study you can find it here.

The invent of Uber and Lyft has only added momentum to these trends. I work with several people that have decided that it makes financial sense to not own a car. They can Uber to and from work each day for about $15. They don’t have car or insurance payments, parking problems, maintenance issues, or worries about gas prices. They also love the idea of having a personal driver on call 24/7. They don’t need to go to the store often because they use Amazon and almost everything is delivered. The graphic below is from a survey performed in 2014. I would argue this trend continues to gain momentum.GM Demand

For those of us who still own cars, we are using Uber and Lyft occasionally which keeps the miles off our own cars. Barron’s published a bullish article on GM and Ford a couple weeks ago. In the article, they cited that the average age of U.S vehicles is 11.4 years old. This might be true, however they did not mention 1) vehicles on the road today are of higher quality and are lasting much longer and 2) total vehicle miles driven peaked in late 2007 and flat lined for about 7 years (This data point has begun to increase over the last year due to low gas prices). There is no way to know how many miles are on these vehicles. Projections for total vehicle miles have been overestimating the data point for several years. Total vehicle miles

According to recent study performed by Deloitte, over a third of Millennials consider modes of transportation other than personal cars as the preferred means of travel. Nearly a third listed a combination of trains, light rail, buses, carpooling, car-sharing, ride-sharing, bicycling, bike sharing, and walking as common means of transportation. If you would like to read this study you can find it here.

PwC estimates that there are 600,000 fewer vehicles on the road in the U.S because of car-sharing. It is projected that 8 million people in the U.S will be sharing cars by 2020. Most researchers say that about 12 cars are lost for every car-sharing vehicle. The number of car-sharing users worldwide is forecasted to grow from 6.5 million people in 2015 at a compound annual growth rate (CAGR) of 32.0 percent to reach 26.0 million people in 2020. Forecasts for the number of cars used for car-sharing services indicate they will grow at a CAGR of 29.6 percent from 123,000 at the end of 2015 to 450,000 at the end of 2020. If 12 cars are lost for every car-sharing vehicle, there will be around 4 million less cars on the road in 2020 compared to today.

Self Driving and Autonomous Vehicles

Autonomous vehicles are coming sooner than most people think.

Self driving

It is important to note that self-driving does not mean autonomous. Self-driving cars in 2020 will be able to accelerate, brake and steer a car’s course without input from the driver. An autonomous car is defined as one in which the driver could be completely disengaged from a vehicle. In fact, the vehicle could move from one place to another without occupants.

According to Navigant Research, there will be 85 million autonomous vehicles on the road by 2035.

At this very moment, there are millions of cars sitting around without their owners in them. Technology companies recognize all of this excess capacity as an enormous opportunity. It is silly that we have so many cars sitting around doing nothing at any point in time. Almost every vehicle that is owned spends more time parked than being driven. Once autonomous vehicles are on the road, I think auto manufactures will be very challenged. Imagine a future in which a company brings a vehicle to you after you request it using your smartphone. Need a ride to Starbucks? A little inexpensive two-seater shows up. Want to buy some furniture? A long bed truck backs into your driveway. In this world, will you really want to pay for a vehicle that has limited capabilities when you could use a variety of vehicles whenever you need them? If you are going to work, the vehicle you take might be the one the family next door used to come home from dinner the night before.

In this environment, automobile manufactures will sell most of their vehicles to large companies with huge fleets. Today, when Ford and GM sell vehicles to rental car companies, the margins are awful. This could be the future of the auto manufacturing industry.

This is obviously a very long term view of the industry. However, GM isn’t exactly thriving in the current environment either. The company is leaner than it once was but faces shrinking margins and the loss of market share.

Valuation

The valuation is probably tricking a lot of investors. On a P/E basis, the company looks very cheap. However, I would caution investors who are buying the stock on a P/E basis. The 4.8x P/E looks attractive but as the temporary favorable cost adjustments reverse, earnings will normalize. From 2012-2014 the average EPS was $2.32. In 2015 it jumped to $5.91 due to the favorable cost adjustments. Using normalized earnings, the stock is fairly expensive considering they have negative growth and a difficult future filled with new competitors.

Berkshire Hathaway 

The Berkshire Hathaway annual meeting was last weekend and it is always special to hear from Warren Buffett and Charlie Munger. Their insights are incredibly valuable and fascinating. I was reviewing the Berkshire portfolio and I noticed GM was in it. After doing a little research, I found an interesting perspective from Charlie Munger. When someone asked him about it a few months ago, he replied. “That’s simple. GM is in the Berkshire portfolio, because a young man who works for Warren likes it, and Warren lets them do what they please. When he was a young man, Warren didn’t like when old men told him what he couldn’t do. So he refrains from that with our young men. I haven’t the faintest idea why he likes it. Maybe it is cheap and there’ll be another god damn government bailout. The industry is too competitive. Everyone relies on the same suppliers, and cars last long time with little service, and leases of cars are all at cheap rents. This has the earmarks of a commoditized and difficult market and will shrink one of these days. If I was investing, I would want something way the hell better than others, and that’s hard to find.”

The Berkshire stake in GM has been accumulated by money manager Ted Weschler. He is a brilliant guy with a terrific track record. I would be interested to hear what he thinks about GM’s future. It is obviously totally different from my view. It sounds like it is also quite different from Charlie Munger’s.

Bottom Line

General Motors has struggled over the last several years. Today the company trades below its 2011 IPO price of $33. I think the operating environment will only get more competitive going forward. The industry is quickly evolving and I am not sure any of the automobile manufactures are investable. The amount of competition coming from technology companies is frightening. I have owned my car for about two years and by my calculation, I have spent around 4% of all my time driving in the last two years. I estimated an hour of each day. This 96% of idle time is a big opportunity for technology companies. We are seeing the competition ramp up and vehicle ownership is on the decline. These macro headwinds may have a large impact on GM’s business going forward.

Disclosure


No Position

 

 

 

Leave a Reply

Your email address will not be published. Required fields are marked *