General Motors: The End of the Cycle as We Know It?

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Earnings from Ford Motors (F) and General Motors (GM) were pretty good. The stocks’ reactions, however, were not as investors fretted that such profits were unsustainable. In writing about General Motors, JPMorgan’s Ryan Brinkman and team call cycle fears “overblown.” They explain why:

Associated Press

GM reported strong 4Q results, capitalizing well upon macro tailwinds in North America and China while proving skillful at navigating macro headwinds elsewhere, such as in South America where it surprised by nearly breaking even. Adjusted EPS tracked $1.39, well above Bloomberg consensus of $1.20 and JPM $1.18, propelled by automotive EBIT of $2,598 mn vs. JPM $2,283 mn. While results were better and strong 2016 guidance reiterated, the stock still lost ground Wednesday, slipping -2.5% vs. the S&P +0.5%, as investors continued to worry about the sustainability of macro trends in the US and China that allowed these markets to perform strongly in 4Q. Starting with China, where macro trends are clearly harder to read, GM commented on its earnings call that 4Q momentum had carried over into 2016, with GM China sales +12% y/y in January, and the industry +10%. So China is not rolling certainly not yet. In gauging the current run-rate of sales and the easing compares through 3Q, we estimate China sales are not likely to show y/y declines until 4Q16, and that full year sales are likely to track higher. Relative the US, where again we see significantly less reason for concern than do investors, we feel GM pushed back effectively on bear arguments, suggesting it was far more likely sales would plateau at a high level than that they would fall materially, citing record fleet age, firm used car prices, widespread credit availability, low fuel prices, strong household balance sheets, and a strong and improving labor market. In the event investors cannot be convinced of the idea that the current strong level of vehicles sales in the US is sustainable medium-term, GM highlighted several industry and company-specific factors that would mitigate the profit impact of any downturn (such as well managed inventories, strong capacity utilization, and lower breakevens, etc.). In short, the sky is not falling. We are actually busy increasing our estimates today, to the high end of guidance (i.e., 2016 EPS of $5.75 v! s. $5.50 prior), on flow through of 4Qs stronger results and continue to recommend shares of GM, which screen highly inexpensive, at just 2.2x NTM EBITDAPO; 5.0x NTM EPS, and 12.9% NTM FCF yield.

RBC’ss Joseph Spak and team argue that General Motors deserves to be priced as if earnings have peaked:

Bottom-line, 4Q15 results were strong and 2016 guidance reiterated. We instead prefer to focus on the peak/plateau debate which GM referenced. For the record, we are in the plateau camp seeing another 2 years of mid-17mm level of US demand before demand starts to turn. But the real issue of importance in our minds as it relates to that debate is not are sales peak, but what to pay for a company that is at or near peak earnings, even if they can stay there for a while. We need to do the math on what earnings looks like if/when there is a downturn. To wit, a typical peak-to-trough decline for US sales is ~25% which would take us to ~13mm. That is about the level of sales seen in 2011 when GM earned ~$7.2bn in NA (vs. $11bn in 2015). That suggests GM would be able to withstand the downturn (GM stating breakeven is 10-11mm) though we could be giving them too much credit because that may just be taking into account volume, and pricing could also crack in a downturn which would make their breakeven higher. But lets give GM the benefit of the doubt on that point. Holding all other regions near todays levels would suggest Auto EBITDA of ~$10.6bn (~12.7bn including China JV income). Applying a mid-cycle 3-3.5x EV/EBITDA multiple would suggest a share price of ~$30-$33. That is probably not enough value for an investor who would first have to deal with riding the eventual downcycle. Some may scoff at using 2x EV/EBITDA multiple to value GM (which is where is it currently trading). And while bulls will argue that is cheap on 2016 or 2017 levels, looking at valuation on anything near-to-mid term when things can’t get much better but could get worse may not be the way to think about it. Price target to $30.

Shares of General Motors have dropped .14% to $28.51 at 2:24 p.m. today, while Ford Motor has ticked up 0.1% to $11.47.

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