General Motors Company (GM) reported third quarter EPS of $0.08 vs. $1.76 in the prior year. Excluding unusual items – a $2.3 billion, $1.24 per share deferred tax adjustment related to the sale of GM’s European operations in 2017 and a ($69 million), ($0.05) per share adjustment to reverse a small gain on an ignition switch recall in 2016 – third quarter non-GAAP EPS was $1.32 vs. $1.71. Analysts had expected EPS of $1.12.
Total revenues, including GM Financial, declined 13.5% to $33.6 billion; but that was still better than analysts’ expectations of $32.7 billion. Automotive revenues declined 16.6% to $30.5 billion. Wholesale vehicle unit sales, excluding joint ventures, declined 19.4% to 1.08 million units. The decline was due to production cutbacks designed to better align dealer inventories with the current sales pace. Retail sales declined 3.1% to 2.32 million units. Excluding the now discontinued GM Europe, retail vehicle sales increased 5.5% to 2.23 million units and GM’s global market share increased from 11.7% to 11.9%, year-on-year.
The decline in sales and profits was therefore expected, as GM moved to rationalize its dealer inventories. Management believes that the company is positioned well for the upcoming fourth quarter and into 2018, both in terms of inventories and with new product launches. Consensus estimates anticipate fourth quarter earnings of $1.40, up 9.4% from $1.28 last year.
Besides the earlier launches of the Chevy Equinox and Chevy Traverse, both crossover vehicles that have received favorable reviews, GM recently introduced two more crossovers, the Buick Enclave and GM Terrain. In China, the company launched or refreshed five vehicles in the third quarter and plans to introduce another six models in the fourth quarter.
GM continues to make progress on its longer-term vehicle strategy. The company has committed to transitioning to all electric vehicles. It current line-up includes the Chevy Volt and Bolt. GM plans to introduce two more electric vehicles in the next 18 months and a total of 20 by 2023.
GM also reported progress on the development of autonomous vehicles (AVs). It is currently testing the first mass-producible AV, a third-generation model, and has a fourth-generation test vehicle in development. It recently purchased Strobe, Inc., whose LIDAR technology uses light to create higher resolution images that help improve the capabilities of AVs. The technology will also help GM reduce AV manufacturing costs. GM has also introduced Super Cruise, a hands-free driving assistance technology, in the Cadillac CT6 and is currently demonstrating its capabilities in test drives from New York to Los Angeles.
Despite the progress made on several fronts this year, GM continues to burn cash and take on more debt. GM’s year-to-date cash burn (i.e. net cash flow used in operating and investing activities, excluding the change in marketable securities) increased from $10.9 billion to $15.3 billion. Similarly, during the same period, the change in GM Financial’s net investment in receivables and leases (i.e. investments less repayments) as a percent of total automotive sales increased from 52.2% in 2016 to 72.9% in 2017. Although much of that debt is in securitizations, which are non-recourse, all of the debt must be kept current in order for GM to maintain its access to capital. GM’s total debt-to-capitalization ratio has increased steadily since 2014. So far this year, it has increased from 63.2% to 68.7%.
As with all auto stocks, GM’s went on a tear at the beginning of September, but has leveled off over the past two weeks. Despite underperforming the market in the first five months of the year, the stock is now up 37.7% (through 10/24) on a total return basis, better than the S&P 500’s 16.6% total return.
Despite that advance, GM’s stock currently trades at only 7.3 times anticipated 2017 earnings and 7.7 times projected 2018 earnings. (It sports a 3.4% dividend yield, to boot.) Consensus estimates anticipate that GM’s (non-GAAP) earnings will decline 4.1% from $6.12 per share in 2017 to $5.87 in 2018. The stock’s extremely low valuation relative to the broader market reflects concerns that the automotive market (at least in the U.S.) is past its peak for the cycle. Furthermore, the current peak demand levels have been sustained by a steady increase in non-prime auto loans. GM’s increasing debt leverage appears to confirm that view.
While it is nice to see GM’s commitment to electric vehicles and the progress that it is making in AV, providing some assurance about the company’s ability to maintain its industry leadership, the near- to medium-term potential of its share price still seems questionable. Of course, the market will do what it will, and GM could trade higher, if the market multiple continues to climb; but I believe that GM will continue to trade at a meaningful discount to the market unless its financial leverage peaks soon and begins to trend downward. This, in my mind, would give investors greater confidence about its ability to manage through the inevitable downside of the cycle.
October 25, 2017
Stephen P. Percoco
Lark Research, Inc.
839 Dewitt Street
Linden, New Jersey 07036
© Lark Research, Inc. All rights reserved. Reproduction without permission is prohibited.