General Motors (GM) – Moving from Buy to Sell
Today we are moving General Motors (GM) from Buy to Sell. General Motors has made a remarkable transition from bankruptcy in 2009 to a highly-profitable and innovative contender in the rapidly changing global auto industry, driven by CEO Mary Barra. However, with the shares at about $62, we think the risk/reward trade-off has moved into unfavorable territory, and are thus moving the shares to Sell.
The potential upside comes from GM transitioning to an electric vehicle world, eventually offering a wide array of luxury and mass-market EVs, along with related services that could be highly profitable. GM’s Ultium battery segment could, theoretically, become a major competitive advantage. In an ideal case, if GM can create a cost-effective and long-range battery when others can’t, GM could have a monopoly on the primary component of EVs, and thus have a huge profit and volume advantage.
But potential downside comes from many sources. Battery technology is being developed by many well-capitalized companies and it’s unlikely that any breakthrough or edge will be enduring. Ultimately, we see batteries degenerating into a low-margin, capital-intensive business. We also see the expansion of EV cars into the mid-priced mainstream segment as being many years away – especially as nearly all of the EVs today are high-end vehicles costing at least $60,000. The future profitability of EVs isn’t clear: High margins for today’s EVs primarily come from their luxury appointments which don’t cost much to produce but add an immense amount of profits – strip out these luxuries and the price per vehicles falls sharply but the costs don’t. This could crimp margins on EVs.
We see the sum-of-the-parts valuation of GMs EV and other advanced technologies using peers like Tesla, Rivian, Lucid and others as not very meaningful – GM will not spin-off its EV or other operations to unlock this comparison. Also, we believe that GM’s investor base is very different from its pure-play speculative competitors’ investor base, such that GM shares won’t capture the (elevated) valuations of its peers.
Other risks include the cyclicality of the auto business – and we’re near the top of the cycle now. A remote but non-zero risk is that relations with China deteriorate further such that the Chinese market becomes sharply less-attractive to GM, removing a major source of profits.
Perhaps the lynchpin of the deterioration in the risk/return trade-off is GMs elevated capital spending. With the price of EV failure so high, we believe GM will not take its foot off the capital spending pedal. We see this permanently elevated spending siphoning off much of the company’s free cash flow indefinitely.
With this Sell, GM has produced about a 69% total return since our initial recommendation on December 31, 2019 and about a 145% total return since the current analyst assumed coverage and re-affirmed the Buy rating on July 1, 2020.