GM Stock: A Significantly Undervalued EV Play

We believe General Motors’ GM recent electric vehicle day was meant to remind investors that the automaker is well on its way to an all-electric future. The company’s 2025 total revenue target is now over US$225 billion, up from the US$195 billion given in October 2021. This increase is from expected electric vehicle revenue of over US$50 billion by then, up from US$30 billion last October. We now model about US$201 billion of 2025 revenue excluding GM Financial, up from US$159 billion.

Offsetting some of the higher revenue is an increase in annual capital expenditure for 2023-25 to US$11 billion-$13 billion from US$9 billion-$11 billion. The company is accelerating EV and autonomous vehicle investments; it previewed many EV offerings planned through 2024 in North America and China while maintaining a 2025 global EV production target of 2 million units, split about evenly between North America and China. Management now expects adjusted earnings per share of US$6.75-$7.25, up from US$6.50-$7.50, and adjusted auto free cash flow of US$10 billion-$11 billion, up from US$7 billion-$9 billion, we suspect due to better working capital and continued strong pricing.

GM expects the EV business to have EBIT margins in the low to mid-single digits in 2025 without any benefit from tax credits from the Inflation Reduction Act. The act gives credits to battery producers, which GM can benefit from via its Ultium Cells battery joint venture with LG Energy Solution. With the tax credits, GM sees 2025 margins comparable with its combustion vehicle business; it estimates credits will add 500-700 basis points of margin and sees the EV business without credits on par with combustion by the end of the decade. Further scale from GM making its own batteries via Ultium and technology advancement is expected to bring cell costs to below US$70 per kilowatt-hour by late in the decade.

Management maintained its 2030 targets for revenue of $300 billion at the midpoint, including the finance arm, and total company adjusted EBIT margins of 12%-14%. All plans for 2030 expansion into insurance, software services, and autonomous vehicles via Cruise remain on target. Ford F has enjoyed—and deserved—positive newsprint for the Mustang Mach-E and F-150 Lightning, but we knew GM was going to make EV noise in 2023 once higher-volume EVs like the Silverado, Blazer, and Equinox start production throughout next year. Buick will receive more EVs in 2023 and 2024 in China and North America, and high-performance EVs are coming from Chevrolet and Cadillac, so there is an enormous GM EV portfolio tailwind coming in 2023 and 2024.

President Mark Reuss introduced plans to save GM $2,000 of distribution and inventory holding costs per vehicle over the next couple of years. These savings will come from regional distribution centers to move ordered vehicles to customers in just a few days and from nearly all dealers signing up for GM’s digital retail platform, which will enable pricing specific to vehicle identification numbers. About 90% of the U.S. population lives within 10 miles of a GM dealership, so we like GM using its distribution center as an advantage. To that point, Reuss was happy to announce that GM dealers have performed over 11,000 service orders for Tesla TSLA owners either because the latter brand didn’t have enough service capability or perhaps some Tesla customers did not want to wait for Tesla service.

CFO Paul Jacobson said that in 2023, tailwinds will come from improving volume on reduced (but not finished) supply chain challenges, lower commodity costs, and clean energy credits. Headwinds next year include expected lower GM Financial pretax income as used-vehicle prices fall and there is lower pension income. Pricing will likely be pressured as industry vehicle supply improves when the chip shortage resolves, but we don’t see GM eager to cut prices to chase market share at the expense of profitability, as it would have before the bankruptcy. Jacobson said that as commodity prices have fallen, pricing has remained stable (likely due to still-low inventory), which has also likely helped lift GM’s 2022 guidance. We see pricing as a key wild card for GM’s 2023 results.

With plenty more EVs on the way, more Ultium battery plants coming, the Ultifi software platform launching next spring in the Cadillac Lyriq, the BrightDrop EV van business already forecasting 2023 revenue of $1 billion after just a few years of existence, and GM having secured binding battery mineral agreements for its 2025 plans, we see the company’s combustion business adequately funding the transition to an all-electric automaker by 2035, per GM’s goal. The October 2021 investor day was a transformative day for GM as it announced its bold plan to be an automotive tech company with 2030 revenue more than doubling from recent levels. However, we sensed even more confidence from management than a year ago in meeting these bold targets. GM has spent years establishing the people and manufacturing base to make its own batteries and grow Cruise into a $50 billion AV business. We believe the potential for significant stock price appreciation exists once the market moves on from recession fears and GM’s EV deliveries begin to be realized, rather than being just projections for the future. That future is finally close at hand.

Key Morningstar Metrics for GM

• Fair Value Estimate: $75
• Star Rating: 5 Stars
• Economic Moat Rating: None
• Moat Trend Rating: Negative
  
  

Economic Moat Rating

GM does not have an economic moat, and we do not expect that to change. Vehicle manufacturing is a very capital-intensive business, but barriers to entry are not as high as in the past. The industry is already full of strong competition, so it is nearly impossible for one firm to gain a durable advantage. Automakers from China and India may soon enter developed markets such as the United States, and South Korea’s Hyundai and Kia have become formidable competitors. Many battery electric startups are emerging in addition to Tesla, such as Lucid LCID, Rivian RIVN, and Fisker FSR. Furthermore, the auto industry is so cyclical that in bad times, even the best automakers cannot avoid large declines in returns on invested capital and profit. Cost-cutting helps ease the pain, but it does not restore all lost profit in bad times.

Fair Value Estimate for GM Stock

We recently raised our fair value estimate to US$75 per share from US$70 after incorporating higher 2025 revenue targets. We are now modeling about US$201 billion of 2025 revenue excluding GM Financial, up from US$159 billion. Offsetting some of the higher revenue is an increase in capital expenditure for 2023-25. GM’s global pension underfunding at year-end 2021 improved to US$5.1 billion from US$12.4 billion at 2020 year-end, mostly helped by the company raising its discount rates. We will continue to review our midcycle margin assumption as GM progresses through its transformative strategy that targets total company 12%-14% EBIT margin by 2030 and revenue of US$275 billion-$315 billion. New asset-light businesses centered on data analytics and subscriptions for performance upgrades and autonomous features should enable margin expansion over time. Our weighted average cost of capital is about 10%. Automotive equity income constitutes about US$10 of our fair value estimate, or about 13%. Our estimate for GM’s midcycle automotive adjusted EBIT margin including equity income (mostly Chinese joint ventures) and Cruise remains about 7% to reflect a midcycle margin encompassing the wide range of possible margins for both good times and bad times.

Risk and Uncertainty

GM’s global pension was underfunded by US$5.1 billion as of Dec. 31, 2021, and the projected benefit obligation would go up if interest rates decline. Management does not expect to be forced to make any major contributions to the U.S. qualified plan for five years, but that assertion is only an estimate, and GM did make a US$2 billion discretionary contribution in early 2016 via a bond offering. An increase in U.S. gas prices is a risk, given GM’s reliance on light trucks, as is the threat of more tariffs and the ever-looming threat of mass recalls and inflation. More vehicles made on the same platform means that a recall can affect millions more vehicles than in the past. New U.S. shutdowns from the coronavirus and a semiconductor shortage remain threats.

GM Bulls Say

• GM North America’s breakeven point of about 10 million-11 million units is drastically lower than it was under old GM. Earnings should grow rapidly as GM becomes more cost-efficient.
• GM’s U.S. hourly labor cost is about US$5 billion compared with about US$16 billion in 2005 under old GM.
• GM can charge thousands of dollars more per vehicle in light-truck segments. Higher prices with fewer incentive dollars allow GM to get more margin per vehicle, which helps mitigate a severe decline in light-vehicle sales and falling market share.
  
  

GM Bears Say

• GM may have to see a U.S. recession to prove it can do much better than old GM before the market will award the stock a higher price/earnings multiple. The recession came in 2020, but the P/E multiple well after the downturn is uncertain.
• Auto stocks often sell off severely because of macroeconomic concerns, even if the bottom-up story looks attractive.
• The U.S. auto market is becoming more crowded each year. Hyundai/Kia, Tesla, new entrants from China, and EV startups may take more share over time from existing players like GM.