GM - General Motors

[vinod1]

I agree on the mindset being difficult to switch off -- we will see this time around whether their recent brush with death will cause the automakers to change their ways. (I think Marchionne & Elkann are a notable exception to the market share mentality you mentioned, btw.)

 

I appreciate the push back. It helps keep us all intellectually honest. :)

 

I look at investments with "glass half empty" hat on so it nice to look at the bright side once in a while :)

 

I have invested in Fiat for the same reason. But that is so leveraged, it is almost like an equity stub.

 

Vinod

[compounding]

I agree that $110 billion and 10% EBIT-margin is more optimistic than I would use as a base case scenario, on the other hand I think the estimates for the other segments were way too conservative. But tailwinds for SUV/pickups (consumer preference and housing recovery) will likely aid GM, so you could probably argue that the probability for the aforementioned scenario to play out should be revised upwards as long as it continues that way.

 

I have a few questions, Vinod, do you have any other evidence than historical margins for estimating margins through the cycle?

 

And I guess to you both, who is adding new capacity in the US except for Volkswagen? Or are you counting the new plants in Mexico? Or leveraging existing facilities in he US?

[wbr]

I think a lot of people view cycles as something nice and smooth like a picture of a sound wave, but in reality cyclical indutries are characterized by booms and busts and between those extremes there is huge grey area. Many remember the recent bust in 08/09, extrapolate this into the future and expect frequent busts as soon as they see record sales just like they expect another crash when the stock market makes new all time highs.

 

Ironically, if busts were so frequent there wouldn't be any big busts. Managements would be hesitant to use leverage and increase capacity too much, investors would be hesitant to invest in car companies at even slightly elevated stock prices. This would make downturns a lot less severe. And when downturns are a lot less severe, people become careless. They think this time it's different. And eventually some of those companies will go into an unexpected recession with too much leverage and capacity and explode.

 

At the same time this big "purge" has a positive effect on the future performance of the survivors and those who emerge bankruptcy. Balance sheets are cleaned up, sector stock prices are low, there is pent up demand and less capacity. Executives tread carefully, they prefere to preserve "a fortress balance sheet" instead of buying back stock.

 

Since it is not clear how long cycles will ultimately be and how they will look like, the best bet is to invest after a big bust because of the factors mentioned above. The companies have a very good chance of doing well and the stock prices might do even better because people will forget what can happen. In those intermediate years (which can be a long time) the companies can grow and expand capacity, because demand is robust.

 

I guess the bottom line is: Just because Americans are buying record amounts of cars doesn't mean that the next bust is around the corner. Investors and management teams are still very careful and the pent up demand has not gone away. On top of that stocks of Ford or GM haven't moved anywhere during 18 months of new record sales. When the language of management changes and they start talking about massive share buybacks and a lot of new capacity and meanwhile the avg car's age is approaching lows I would wanna be as far away as I could, but right now it seems like a good place to be in market that does not offer a lot of bargains.

[merkhet]

I agree that $110 billion and 10% EBIT-margin is more optimistic than I would use as a base case scenario, on the other hand I think the estimates for the other segments were way too conservative. But tailwinds for SUV/pickups (consumer preference and housing recovery) will likely aid GM, so you could probably argue that the probability for the aforementioned scenario to play out should be revised upwards as long as it continues that way.

 

I have a few questions, Vinod, do you have any other evidence than historical margins for estimating margins through the cycle?

 

And I guess to you both, who is adding new capacity in the US except for Volkswagen? Or are you counting the new plants in Mexico? Or leveraging existing facilities in he US?

 

I'm counting adding capacity at existing plants.

 

 

[plato1976]

why is owner's earning $2 more?

 

My back-of-the-envelope calculation has GNMA doing about $11 billion pre-tax in 2015.

 

If GME gets break even and GMIO/GMSA + GM Financial/Corporate net one another out, then you're looking at more than $5 per share of EPS and roughy $7 per share of owners earnings -- put a 12.2x multiple (industry average P/E) on either of those numbers and GM is a home-run.

 

And that multiple is probably a bit low -- we have close to 10 million units of pent-up auto demand, which indicates that we are nowhere near the end of the replacement supercycle.

[merkhet]

why is owner's earning $2 more?

 

My back-of-the-envelope calculation has GNMA doing about $11 billion pre-tax in 2015.

 

If GME gets break even and GMIO/GMSA + GM Financial/Corporate net one another out, then you're looking at more than $5 per share of EPS and roughy $7 per share of owners earnings -- put a 12.2x multiple (industry average P/E) on either of those numbers and GM is a home-run.

 

And that multiple is probably a bit low -- we have close to 10 million units of pent-up auto demand, which indicates that we are nowhere near the end of the replacement supercycle.

 

Their D&A is $8 billion or thereabouts, and I think their maintenance cap-ex requirements are significantly less than that.

[compounding]

Great post wbr.

 

Capex was $8 billion in 2012 and $7.5 billion in 2013 according to the annual reports. They mentioned at their investor day that they expect capex to be ~5% of revenue in a run-rate basis according to someone (can't remember who I'm afraid) earlier in is thread, which would be in line with he last two years.

[merkhet]

Great post wbr.

 

Capex was $8 billion in 2012 and $7.5 billion in 2013 according to the annual reports. They mentioned at their investor day that they expect capex to be ~5% of revenue in a run-rate basis according to someone (can't remember who I'm afraid) earlier in is thread, which would be in line with he last two years.

 

So I'm differentiating from the run-rate and the maintenance cap-ex. The former almost certainly prices in growth cap-ex while the latter does not, and I think the run-rate you're referencing is probably inclusive of growth cap-ex.

 

In any case, if you take the % of revenue as cap-ex over the last decade for Ford, you get 4% of revenues, and I suspect that you have a bit of growth cap-ex in that average as well.

 

2009 3.86%

2010 3.17%

2011 3.15%

 

Those are the lowest % for cap-ex during the last decade for Ford. There's probably no growth-cap ex in those numbers.

 

My guess is that maintenance cap-ex for GM is closer to $5 billion than $8 billion.

[Mephistopheles]

Is it possible to short the C warrants, and if so can anyone look up the borrowing cost? With my broker (Merrill Edge) you can't short non-marginable securities.

 

They are trading for $.87, expire on 12/31/15, and have an exercise price of $42.31. Meanwhile the ask for the January 2016 $42 strike call option was last quoted at $.84. It should be selling for at least $.31 more than the warrants, or $1.18, not to mention the extra two weeks of time value and the value of deferring your taxes for an extra year by closing your position in 2016 rather than 2015 like you would have to for the warrants.

 

I've never shorted before but this seems like a good arbitrage opportunity depending on the cost of borrowing the securities. The difference between what the ask price is and what it should be is $.34. If it were to jump to the proper price, that would be a difference of 40.5%. If it is possible to borrow, I imagine it wouldn't cost that much, though I have no clue.

 

Would love to hear all your thoughts on this.

 

Edit: Silly me, I didn't think that they shouldn't be trading at a $.31 difference, because they are way out of the money.

[cmlber]

why is owner's earning $2 more?

 

My back-of-the-envelope calculation has GNMA doing about $11 billion pre-tax in 2015.

 

If GME gets break even and GMIO/GMSA + GM Financial/Corporate net one another out, then you're looking at more than $5 per share of EPS and roughy $7 per share of owners earnings -- put a 12.2x multiple (industry average P/E) on either of those numbers and GM is a home-run.

 

And that multiple is probably a bit low -- we have close to 10 million units of pent-up auto demand, which indicates that we are nowhere near the end of the replacement supercycle.

 

Their D&A is $8 billion or thereabouts, and I think their maintenance cap-ex requirements are significantly less than that.

 

Merkhet, I would be careful not to use the D&A line without adjusting it to come up with your owner earnings.  GM includes impairment charges in it's D&A line and management margin targets back out all of the impairment charges, which have been significant.  So if you are using managements margin targets to figure out EBITDA, I wouldn't use an $8 billion D&A number and assume owner earnings are significantly higher than gaap earnings.  Capex should be running a good amount higher than true "D&A" for the next several years, but since a lot of that is clearly growth capex, it's probably a wash.

[vinod1]

I agree that $110 billion and 10% EBIT-margin is more optimistic than I would use as a base case scenario, on the other hand I think the estimates for the other segments were way too conservative. But tailwinds for SUV/pickups (consumer preference and housing recovery) will likely aid GM, so you could probably argue that the probability for the aforementioned scenario to play out should be revised upwards as long as it continues that way.

 

I have a few questions, Vinod, do you have any other evidence than historical margins for estimating margins through the cycle?

 

And I guess to you both, who is adding new capacity in the US except for Volkswagen? Or are you counting the new plants in Mexico? Or leveraging existing facilities in he US?

 

We are not really using historical margins in the sense of last 20-30 years averages. I am basing the margins on what GM has achieved in the last 3 years and what management say their "mid decade" targets are.

 

NA auto industry moved from a poorly run charity to a decent but not great business. This is not an industry that is going to churn out 20% ROE year in year out. Auto companies are forced to take risks with engine technology, batteries, safety, light weight materials, autonomous driving, etc to keep up with competition or meet regulatory requirements (EPA milage standards). The risk is borne by the auto companies, and if they succeed in one particular technology they get to reap the benefit for only a few years before others catch up. If the tech investments fail, well the company is left holding the bag. The benefits accrue to the customer. There is simply no major competitive advantages for the companies in this industry. This is just one part of the story.

 

Auto companies have a positive cash flow during good years, as the dealers pay upfront when they take delivery but auto companies pay quite a bit late for their suppliers. This looks pretty good during an up cycle. When sales stagnate a bit or go down this cycle reverses and companies burn cash - they can easily burn cash equal to 5% of sales. This is the dynamic I am referring to when I mention looking at the last 20 - 30 years Accounts Payables and Account Receivables. This is also why I cringe every time I see EV calculations that subtract all the cash. This works for Walmart or Costco which are pretty non-cyclical, but for auto companies, it just does not make sense as they need this cash as much as they need steel.

 

I am bringing up all this just to point out that when management says they have a target of 10% EBIT margins, these are not margins that could be sustained. They are talking about peak margins when everything goes right. As WBR mentioned and I agree pretty much with him on what he says about the cycles. They way I estimate through the cycle margins is to assume say a 7 year  business cycle, through in a couple of years of peak margins, a couple of years of middling margins and a year or two of low margins. This is almost certain to be wrong, but I cannot think of any other way.

 

When talking about capacity I am talking about all of NA. All three NA companies are ramping up. That might be good sign for the immediate future but not if you look out even a couple of years ahead.

 

Vinod

 

 

[vinod1]

Great post wbr.

 

Capex was $8 billion in 2012 and $7.5 billion in 2013 according to the annual reports. They mentioned at their investor day that they expect capex to be ~5% of revenue in a run-rate basis according to someone (can't remember who I'm afraid) earlier in is thread, which would be in line with he last two years.

 

So I'm differentiating from the run-rate and the maintenance cap-ex. The former almost certainly prices in growth cap-ex while the latter does not, and I think the run-rate you're referencing is probably inclusive of growth cap-ex.

 

In any case, if you take the % of revenue as cap-ex over the last decade for Ford, you get 4% of revenues, and I suspect that you have a bit of growth cap-ex in that average as well.

 

2009 3.86%

2010 3.17%

2011 3.15%

 

Those are the lowest % for cap-ex during the last decade for Ford. There's probably no growth-cap ex in those numbers.

 

My guess is that maintenance cap-ex for GM is closer to $5 billion than $8 billion.

 

What is growth capex for auto companies? What are you excluding?

 

To me pretty much all they spend - except brand new additional capacity - is maintainance capex. Battery tech? Autonomous driving? Aluminium body? Model refresh? Moving to a standard platforms? They need all these investments to stay in place - else they fall behind the others. This to me is maintainance capex.

 

Vinod

[merkhet]

Merkhet, I would be careful not to use the D&A line without adjusting it to come up with your owner earnings.  GM includes impairment charges in it's D&A line and management margin targets back out all of the impairment charges, which have been significant.  So if you are using managements margin targets to figure out EBITDA, I wouldn't use an $8 billion D&A number and assume owner earnings are significantly higher than gaap earnings.  Capex should be running a good amount higher than true "D&A" for the next several years, but since a lot of that is clearly growth capex, it's probably a wash.

 

Can you show me this? I don't recall this, but my memory could just be faulty.

 

What is growth capex for auto companies? What are you excluding?

 

To me pretty much all they spend - except brand new additional capacity - is maintainance capex. Battery tech? Autonomous driving? Aluminium body? Model refresh? Moving to a standard platforms? They need all these investments to stay in place - else they fall behind the others. This to me is maintainance capex.

 

Vinod

 

Some cap-ex goes towards increasing market share. Some cap-ex does not. The former is growth cap-ex.

[cmlber]

Merkhet, I would be careful not to use the D&A line without adjusting it to come up with your owner earnings.  GM includes impairment charges in it's D&A line and management margin targets back out all of the impairment charges, which have been significant.  So if you are using managements margin targets to figure out EBITDA, I wouldn't use an $8 billion D&A number and assume owner earnings are significantly higher than gaap earnings.  Capex should be running a good amount higher than true "D&A" for the next several years, but since a lot of that is clearly growth capex, it's probably a wash.

 

Can you show me this? I don't recall this, but my memory could just be faulty.

 

 

Well every time management talks about margins, whether it's current or target margins, they use "adjusted" EBIT right?  The adjustments are backing out impairments, you can see that in the reconciliations that they do at the end of the slide decks quarterly.  The assumption in doing that is that these impairments are one time.

 

If you look at the bottom of page 37 of the 2013 annual report, it says

 

"Depreciation, amortization and impairments included goodwill impairments of $0.5 billion, $27.1 billion and $1.3 billion and impairment charges of property and intangible assets of $1.4 billion, $5.5 billion and $0.1 billion in the year ended December 31, 2013, 2012 and 2011." 

 

So $1.9 billion of the $8 billion number shouldn't really be called "D&A" in your owner earnings calculation.

[merkhet]

Ah, yes. Thanks.

 

You're right that the walk-back of in each of the four earnings presentations for the adjusted EBIT adds up to $1.9 billion, so the $5 of EPS will approximate owner's earnings. Though there's still the small matter of the fact that they're not paying cash taxes temporarily, so that should probably goose owner's earnings as well.

[txlaw]

Auto companies have a positive cash flow during good years, as the dealers pay upfront when they take delivery but auto companies pay quite a bit late for their suppliers. This looks pretty good during an up cycle. When sales stagnate a bit or go down this cycle reverses and companies burn cash - they can easily burn cash equal to 5% of sales. This is the dynamic I am referring to when I mention looking at the last 20 - 30 years Accounts Payables and Account Receivables. This is also why I cringe every time I see EV calculations that subtract all the cash. This works for Walmart or Costco which are pretty non-cyclical, but for auto companies, it just does not make sense as they need this cash as much as they need steel.

 

I am bringing up all this just to point out that when management says they have a target of 10% EBIT margins, these are not margins that could be sustained. They are talking about peak margins when everything goes right. As WBR mentioned and I agree pretty much with him on what he says about the cycles. They way I estimate through the cycle margins is to assume say a 7 year  business cycle, through in a couple of years of peak margins, a couple of years of middling margins and a year or two of low margins. This is almost certain to be wrong, but I cannot think of any other way.

 

Management has said that their 10% margin target for NA is supposed to be both a mid-decade target and a mid-cycle target.  I agree, though, that one ought to use far more conservative numbers when doing the valuation and be pleasantly surprised if they get there and sustain the margin. 

 

My views are similar when considering Sergio's targets at FCA -- great aspirational targets but be conservative and pleasantly surprised if it happens.

 

As to capex, I believe Akerson once said that they are trying to have full-cycle capital spending of about $8 billion a year -- hence the need for a fortress balance sheet.  (If someone can point to the source, that would be much appreciated; I can't find where I got that from.)  So I don't think maintenance capex should be viewed as that much different from depreciation and amortization in this case.

[cmlber]

Ah, yes. Thanks.

 

You're right that the walk-back of in each of the four earnings presentations for the adjusted EBIT adds up to $1.9 billion, so the $5 of EPS will approximate owner's earnings. Though there's still the small matter of the fact that they're not paying cash taxes temporarily, so that should probably goose owner's earnings as well.

 

No problem.  They plan on investing $14 billion from 2014-2018 in China, which works out to $2.8 billion per year.  I assume this is pretty much all growth capex (going from 3.5m units of capacity to 5.4m units of capacity).  I'm not sure if the JV partner splits this figure or not, but I think assuming D&A is true maintenance capex is a safe bet given that China investment.

 

I wouldn't add the lack of cash taxes to owner earnings, since putting a multiple on that number assumes it is sustainable.  I just reduce the enterprise value by the NPV of tax assets and use a fully taxed owner earnings number.

[merkhet]

Yes, I mean owner's earnings in terms of cash in your pocket and not a number you can slap a multiple on, since the lack of cash taxes runs out when their DTA does. Hopefully, they put that cash tax "bonus" to good use buying back some stock -- after all, they have $28 billion of cash, might have $11 billion of operating income, and only spend about $2 billion on dividends and $8 billion on cap-ex (growth & maintenance).

 

txlaw, I remember the same Akerson statement that you do, but I cannot, for the life of me, find a direct quote on it. The closest I found was the following -- http://www.autonews.com/article/20131126/OEM/131129895/gm’s-$27-billion-cash-hoard-seen-tempting-activists

 

At the same time, Akerson already has developed a strategy that calls for spending $8 billion annually on capital expenditures. GM also had $33.7 billion in unfunded pension and other retiree costs at the end of September, according to slides posted to the company’s website in October.

 

“If we have a fortress balance sheet, we will be able to invest as and when we need to through the cycle,” Dan Ammann, GM’s chief financial officer, said during a conference in June.

 

“We will not be in a position where this company was several years ago where, when the business turned down, things got tight.”

 

I interpret this to mean that the $8 billion serves both a growth cap-ex and maintenance cap-ex purpose.

[merkhet]

Another possibility is that we are both remembering the wrong Dan as Daniel Ammann has mentioned the $8 billion number multiple times as well.

 

http://www.bloomberg.com/news/2012-02-16/gm-earns-record-9-19-billion-net-income-while-opel-loses-money.html

 

“For 2012, we expect the global industry to continue to rebound and we anticipate being able to grow the top-line,” Akerson said on a conference call today.

 

The automaker said it plans to spend $8 billion on capital expenditures this year as it invests in new products, an increase over last year’s $6.2 billion.

 

“What we’re doing is really building back up from some very depressed capital spending levels in the 2008 and 2009 time frame,” Ammann said. “There’s a little bit of catch up going on.”

 

Though in another interview, he states that the $8 billion might be a normalized number.

 

http://ww2.cfo.com/profiles/2013/02/in-the-fast-lane-at-gm/

 

In a normal year, says Ammann, GM wants to spend around $15 billion on the future — $8 billion in capital expenditures and “another $7 billion or $8 billion” on engineering expense. But between 2007 and 2009, the capital number “hit the trough,” he says, falling to $3 billion or $4 billion. “And the cost of that is not just the fact that you don’t have new product in the market, but also that you spent a ton of money engineering things that never came to market. We estimated that we were wasting about a billion dollars a year on investing in projects that would ultimately be canceled.”

 

I suppose even if $8 billion is the right number for capital expenditures going forward, you'd have to normalize the operations in GME/IO/SA and Financial, so it's probably, at the very least, a wash.

[txlaw]

To the extent that $8 billion is the normalized or "steady state" number throughout a cycle for GM, I think we have to treat it entirely as maintenance capex associated with a "natural" growth rate.  Because it sounds to me like close to $8 billion gets spent even when volumes and revenue is on a down trend.

 

But it does seem like there is a bit of confusion as to what the capital spending policy actually is.

[plato1976]

So the story is clear with a normalized FCF of $5 per share

With price at $33 it's a 6.6x without considering the extra cash

 

To the extent that $8 billion is the normalized or "steady state" number throughout a cycle for GM, I think we have to treat it entirely as maintenance capex associated with a "natural" growth rate.  Because it sounds to me like close to $8 billion gets spent even when volumes and revenue is on a down trend.

 

But it does seem like there is a bit of confusion as to what the capital spending policy actually is.

[txlaw]

So the story is clear with a normalized FCF of $5 per share

With price at $33 it's a 6.6x without considering the extra cash

 

To the extent that $8 billion is the normalized or "steady state" number throughout a cycle for GM, I think we have to treat it entirely as maintenance capex associated with a "natural" growth rate.  Because it sounds to me like close to $8 billion gets spent even when volumes and revenue is on a down trend.

 

But it does seem like there is a bit of confusion as to what the capital spending policy actually is.

 

Yeah, I personally think that when you think about GM very conservatively, it's still ridiculously cheap. 

[Mephistopheles]

So the story is clear with a normalized FCF of $5 per share

With price at $33 it's a 6.6x without considering the extra cash

 

To the extent that $8 billion is the normalized or "steady state" number throughout a cycle for GM, I think we have to treat it entirely as maintenance capex associated with a "natural" growth rate.  Because it sounds to me like close to $8 billion gets spent even when volumes and revenue is on a down trend.

 

But it does seem like there is a bit of confusion as to what the capital spending policy actually is.

 

And of course if rates move up then we earn more on that cash and the pension shrinks.

[cmlber]

To the extent that $8 billion is the normalized or "steady state" number throughout a cycle for GM, I think we have to treat it entirely as maintenance capex associated with a "natural" growth rate.  Because it sounds to me like close to $8 billion gets spent even when volumes and revenue is on a down trend.

 

But it does seem like there is a bit of confusion as to what the capital spending policy actually is.

 

I don't think all of the $8b he refers to as "normal" is maintenance capex.  GM's projection is for global auto demand to grow from ~80m units to ~130m units through 2030.  So part of GMs "normal" year will be capturing some of that annual demand growth through capacity expansions in China and emerging markets. 

[txlaw]

To the extent that $8 billion is the normalized or "steady state" number throughout a cycle for GM, I think we have to treat it entirely as maintenance capex associated with a "natural" growth rate.  Because it sounds to me like close to $8 billion gets spent even when volumes and revenue is on a down trend.

 

But it does seem like there is a bit of confusion as to what the capital spending policy actually is.

 

I don't think all of the $8b he refers to as "normal" is maintenance capex.  GM's projection is for global auto demand to grow from ~80m units to ~130m units through 2030.  So part of GMs "normal" year will be capturing some of that annual demand growth through capacity expansions in China and emerging markets.

 

Right, that's kind of why I talked about associating that capex with a "natural" growth rate.  Capital spending that generates new sales in emerging markets might be required to offset sales reduction in the developed markets. 

 

For example, GM could lose market share in the US, and if the size of that market finally plateaus or even shrinks (think disruptions, such as car sharing, self driving cars, increased public transport, etc.), they would need to spend money elsewhere to maintain sales and profits.

 

We don't know how things will turn out, so best to be conservative because of the nature of the industry.