Complicated Times Ahead for U.S. Automakers

This morning, the stock prices of GM and Ford tanked by about 4% each in response to a decline in April auto sales.

My first response, of course, was to have a brief heart attack. But in an effort to avoid giving in to my cognitive biases I decided to head to the news and see the details. The crux of today’s freakout seems to come from the fact that it’s seen as a confirmation of the recent narrative among automaker investors that auto sales are reaching a medium-to-long-term peak, which might be true for a few reasons. At the same time, I’m very hesitant to see this month’s numbers as actually indicative of a significant trend, for reasons I’ll explain.

First, the U.S. market’s current place in the credit cycle might be pushing consumers away from buying cars at the moment. Following the 2009 financial crisis, consumers held off on making large purchases, and in the last few years much of this pent-up demand has been released as consumers finally regain the confidence to buy medium-term necessities like cars. One of the reasons that mattress stores seem to be on every corner in the last few years is that mattresses were one of the first items Americans began to purchase again, fueling huge sales increases. Similarly, car and truck sales have been swelling over the last year or two, but that trend might be coming to a temporary close.

Additionally, Americans are finding it harder to take out loans to buy cars. After several years of lending standards loosening, with rises in subprime loans and borrower delinquencies, lenders are once again tightening up in anticipation of a credit correction. In general, the market is gradually becoming more debt-phobic recently. This means that consumers with poor credit might be forced to hold off on making auto purchases.

Secondly, some systematic trends might be affecting Americans’ demand for autos for good. Ridesharing platforms like Uber and Lyft seem to be reducing appetite for cars, particularly cutting into taxi and rental car fleets. Truck sales remain more steady. Technological transitions are also putting automakers behind the times. Much of Ford’s decline in net earnings from last year is actually a result of rising production costs as some materials increase in price. Additionally, a heightened demand for electric cars in response to environmental concerns and fuel prices mandates that automakers start looking towards more powerful renewable batteries as alternatives to the current model of low-capacity lead-acid batteries and gasoline combustion engines, a major design overhaul. You can read more about that trend in our most recent industry report.

However, I’m not sure that today’s price movement is really a direct indicator of those factors so much as a feedback loop. The press coverage of the sales reports has been dominated by negative speculation, but leaves out a few key points.

Ford’s April sales are down by 7% compared to April 2016, which admittedly is a big hit. March sales, though, were actually down by exactly the same amount. GM’s sales were up 2% in March and down 6% in April, which looks bad on its face, but this movement is likely artificial. GM’s sales to dealerships have been inflated for the past few months as it tried to build up inventory in front of it in anticipation of temporarily shutting down some factories to retool them to make new models. This production rush slowed down in April. If anything, one might have expected March sales to be stronger. Put a different way, it seems to me that for both GM and Ford we didn’t learn anything this morning we couldn’t have guessed a month ago.

Another reason I’m hesitant to discount Ford or GM is that they both have a long way to fall. Most of their low valuation seems to be pessimism about their future prospects for adaptation to the market, but currently they both have extremely strong earnings relative to their market valuation. Ford’s P/E ratio at the time of writing is a low 11.65, and GM’s an astonishing 5.14 (companies are typically in the 20-25 range), suggesting substantial undervaluation. Our findings in the energy storage report and the news that GM is prepping for design changes make me cautiously optimistic that GM at least, and perhaps Ford, are in their own way adapting to changes in the automobile market.

It’s certainly true that the future of these companies is uncertain, but far from inevitable decline it seems that their success in years to come will be dependent on their ability to innovate and to instill confidence in investors. A close eye on them both is warranted.

Until next time,

Conor

Full disclosure: I have a minor stake in both securities discussed.

The featured image of a GM Fairfax Assembly Plant worker is licensed courtesy of General Motors.

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