For the past several months, we’ve been bullish on the resumption in demand for automobiles in the US. We’ve seen the projected SAAR’s (seasonally adjusted annual rates) at Ford (F), General Motors (GM), and Chrysler (part of Fiat) steadily increase during this time. However, the performance of the stocks has not yet followed suit. But while we remain very bullish on the prospects of Ford (which we hold in our Best Ideas portfolio), we think General Motors has a less certain future.
Unclear path, unclear products
GM is lacking a cohesive product strategy. CEO Daniel Ackerson is not an engineer of the same ilk as Allen Mullaly of Ford, but he did help lead Nextel (S) through a period of rapid revenue expansion. However, since he spent most of his career in communications followed by a stint in private equity, we feel Ackerson doesn’t have the same industrial know-how and overall skill that Mullaly does. Mullaly came from aerospace giant Boeing (BA).
Ackerson’s lack of engineering prowess and innovation shines through in terms of the firm’s product offerings. Unlike Ford, which boasts several top-sellers like the Focus, Fusion, and the F-150, GM lacks differentiated main-stream products. Malibu and Cruze sales have been fairly mediocre, while Nissan (NSANY) and Toyota (TM) have rapidly won back share in the mid and low-end of the market. Even sales of the Chevy Volt, once billed as the company’s savior, have been a flop thus far. On top of a recall, sales of the vehicle have slowed to less than 1,500 units in April.
Meanwhile, Buick sales have fallen 16% year-to-date, and Cadillac, once an innovator in American luxury, has seen sales drop 24% thus far this year. Cadillac has moved away from its diverse product offering to become more akin to BMW in that it essentially offers one vehicle in several different iterations. Yet, the numbers show that this strategy is failing. What appears to be working for both Audi and BMW doesn’t seem to resonate with Cadillac buyers, which we think are a different breed than those buying German automobiles.
Poor operations
While Ford pushes to expand operating margins, operating profits at GM languish in the low 5% range. Volkswagen, on the other hand, experienced an operating margin of about 7% during 2011. When we’re dealing with billions of dollars in sales like at General Motors and Volkswagen, 200 basis points of operating leverage (higher margin) translates to billions in pre-tax operating profit. Unlike Ford, which is moving to the One Ford platform for operational efficiencies, GM doesn’t have a clear plan that will lead to operating-margin expansion, in our view.
Even though GM’s operating margin will exceed that of Toyota (TM) for this upcoming fiscal year, as the latter dealt with the aftermath of the Japanese earthquake (and production issues), we don’t see GM being more profitable over the long term. We’d like to see GM focus on profitable growth, not growth for growth’s sake.
Bailout leads to a great balance sheet
While it may struggle on the operational side, GM certainly has a pristine balance sheet. Its current net-cash position is around $11 per share, a significant portion of its current share price. There’s no doubt the business is cheap (its trading at the low end of our fair value range) even if pension issues arise in the next few years. Pension obligations are the biggest threat to GM’s cash hoard, though Ford is certainly not immune to them either. Still, the company is devoid of GMAC, now rebranded as Ally Bank, and GM hardly holds any automotive debt ($3 billion). Undoubtedly, the $30 billion+ in pension and retirement obligations weighs on investors’ minds, but we think short-term liquidity at GM is more than adequate.
Another positive, unrelated to the bailout, is the company’s strength in China. Though sales in China aren’t extremely profitable yet, we suspect that as real wealth grows in the region, so will the demand and the price of cars. Currently, the Chinese market is highly fragmented and reminiscent of the early days of the US market, with various brands and manufactures. As is the case with all consumer companies, GM faces the real threat of complete copies (and no protection of intellectual property), and a country thirsty for luxury items. Cadillac is rather popular now, but so is every other luxury car maker.
Ultimately, given its risk profile, we think shares of GM are trading at the low end of its fair value range (which is based on the margin of safety band we assign to the stock); however, we still prefer Ford both on a fundamental and on a valuation basis. GM seems to have a leg up in China, but in a rapidly developing country, that could change any minute. All things considered, we think Ford is the superior risk-adjusted way to play the global automotive recovery.
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