GM has a ‘Rembrandt in the Attic’: Sizeable Exposure to Electric Vehicle Technology
Everyone can appreciate the potential growth of Electric Vehicles (EVs) relative to traditional combustion engine cars. It makes perfect sense as these new electric cars will help solve a lot of environmental problems so all indications are that more and more EVs will replace combustion engine cars. As those of you that have read some of my previous posts will know, I make every effort to play a high profile explosive growth trend like this in a more risk averse way. Tesla and the other pure play electric vehicle manufacturers are clear beneficiaries of this trend but are now incredibly highly valued (and therefore high risk) and really let’s not forget the challenges they face in building their infrastructure and brands from scratch. Even to have any chance at gaining a decent market share in the automotive sector like General Motors or Ford will potentially need vast amounts of extra capital from investors. Within this context, I believe my holding in GM represents a classic deep value “Rembrandts in the Attic” play: thanks to its (up to recently) completely ignored but actually incredibly sizeable EV exposure, it is in my opinion a far more attractive investment proposition. Within this context, I believe my holding in GM represents classic deep value.
This article is for illustrative purposes and is not intended as investment advice.
“Rembrandts in the Attic” Thesis:
When you think of the best electric vehicle stocks, General Motors is probably not the first one to come to mind. But I believe investors have been too quick to count it out. From its brand loyalty to its autonomous EV potential, General Motors could be a very different company a decade from now, and today I would like to talk about why investors stand to be handsomely rewarded at current prices. GM stock is an EV play that provides long-term exposure to next-generation auto tech at an extremely low valuation.
General Motors designs, builds and sells trucks, crossovers, cars and automobile parts worldwide. The Company also provides automotive financing services through General Motors Financial Company, Inc. Its brands offer luxury cars, crossovers, sport utility vehicles (SUVs) and sedans. The Company’s Car-and Ride-Sharing Maven is a shared vehicle marketplace. Through its subsidiary, OnStar, LLC (OnStar), it provides connected safety, security and mobility solutions for retail and fleet customers. GM Cruise is its global segment engaged in the development and commercialization of autonomous vehicle technology.
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Transformational change in a business with sizeable hidden assets
The old GM was a car manufacturing and finance company. The new GM will be a manufacturing and EV technology company. Uniquely, it is able to recycle its sizable cash generation from its legacy businesses to gain large footholds in huge growth markets.
Let’s look at how the company has started to move away from its legacy businesses. Firstly, GM continues to move away from traditional car finance. It will get $2.5 billion selling its credit card unit to Goldman Sachs. Goldman also says it will make GM’s credit card an “e-commerce portal,” handling financing on car purchases. Moving big credit decisions and payments online, as companies like Repay Holdings already do, has the added bonus of potentially accelerating car purchases.
Secondly, back in December 2019, General Motors announced a joint venture with the South Korean company LG in making electric batteries for a new EV truck. Don’t forget, the company still expects billions of dollars in profit from defence contracts. That’s money it can put into its new EV focus, for example the $2.3 billion battery plant in Lordstown, Ohio, being built with South Korea’s LG. Yes, GM hasn’t totally caught up with Tesla in batteries or EV production yet but it definitely shows every chance of grabbing a sizable market share in these newer markets without needing any more investor money to do it.
In fact, GM continues to insist it will have 22 new EVs by 2022, and claims some will get 400 miles between charges with a new “Ultium” battery. Based on the above, GM can be seen as an EV stock with an attractive valuation.
The Nikola Debacle Highlighted GM’s Portfolio of Technology Assets
In what came as a surprise to the market, EV trucks favourite Nikola and General Motors announced a new partnership in September 2020. Looking at the deal more closely, it was clear what Nikola got: manufacturing, batteries, purchasing power, and perhaps validation. But GM got something even more important: belief. I must admit: it was the event that made me personally sit up and take a closer look! For years now, General Motors has been trying to convince investors that its suite of new technologies deserves a higher PE multiple than its current single-digit one.
In the event, the Nikola deal floundered (without GM paying over any cash) as the startup company and its founders quickly became surrounded by charges of fraud. As I write, it is unclear exactly how close a partnership may eventually ensue but what we do know is that GM has said it is dropping its plan to build the Nikola Badger electric/fuel cell pickup truck and it is no longer taking a stake in the controversial company. The two companies may eventually strike some sort of deal but it would seem very likely that GM now gets more control over both the design and manufacturing at the truck company, or pays substantially less.
The market rightly recognises that in terms of technology exposure, GM’s majority stake in Cruise, an autonomous-driving platform is very valuable. Cruise competes head on to deliver fully self-driving cars with Alphabet-founded Waymo and Tesla, among others. The unit is valued at about $30 billion, based on recent investments. That figure alone is 44% of GM’s current market capitalisation!
But GM has more than just Cruise, as the Nikola potential tie up made clear. The upstart truck maker wanted to bypass its own battery and fuel-cell technology in favour of GM’s Ultium battery platform, citing scale and cost savings.
If the battery decision was a surprise, Nikola’s decision to buy fuel-cell technology from GM was a real shocker. GM doesn’t talk much about its Hydrotec fuel-cell platform - Hydrotec hadn’t had a press release on its website since 2017 - but that’s what Nikola planned to use in its fuel-cell-powered trucks. Truck companies such as Cummins (which I will also write about in detail at another time) and fuel-cell providers like Plug Power talk about a hydrogen future as the best environmental solution of all. But the topic doesn’t come up much on GM investor calls.
It will now. Morgan Stanley analyst Adam Jonas even wondered in a recent research report if GM has a “stable of potential unicorns,” referring to the name given to privately held billion-dollar tech startups. “GM’s strong share price reaction….reflects the market’s increasing confidence in the broader narrative around GM’s willingness to explore the unlocking of hidden value through bold action,” Jonas wrote.
It is important to note that GM doesn’t make the batteries - no electric-vehicle company completely does. GM’s so far have come from LG, while Tesla sources its battery manufacturing technology from Panasonic - and has achieved industry leading per-charge EV range in the process. But EV makers have to combine batteries with software and hardware to make a functioning EV. It’s a little like combining a gasoline engine with a transmission, fuel, and exhaust system.
Growing on all cylinders!
We have seen a huge rise in GM’s share price in the past couple of months. The latest catalyst was the company’s November earnings announcement. This showed non-GAAP net income of $5.3 billion, $2.83 per share when diluted and adjusted, on revenue of $35.5 billion, with operating cash flow was $9.9 billion, more than double 2019’s figure. That means there’s plenty of cash to manage GM’s long-term debts of $83 billion and maintain its pivot toward electric vehicles. CEO Mary Barra says she intends to use profits from GM’s big trucks to fund a new line of electrics, and electric vehicle business models. But until recently Wall Street was treating the older operations as dead money, preferring electric start-ups like Nikola. Instead, GM plans to spend $5.4 billion per year releasing 30 electrics by 2025, representing 40% of its production. The other benefit to the group is that the efficiency of electrics means it no longer has to fight over emissions standards.
GM is also seizing new business opportunities created by data. GM will sell auto insurance through its OnStar system, which collects data on a car’s use. OnStar was originally pitched as a safety feature, a way to connect with operators during a breakdown. The use-based policies will debut in Arizona, basing prices not just on miles driven but on data about how the miles are driven.
Hidden asset: A Sizeable Battery & EV Trucks Business
Its new EV battery plant, in a joint venture with LG Chemical , being built in Lordstown, Ohio, will produce 30 gigawatts (GW) of capacity. It expects to get the production price below $100 per kilowatt-hour (KWh).
This gigaplant will be competitive with Tesla’s plants. This $100/kWh is important since it is a demarcation line for EVs. This is the point where most analysts believe that it is cheaper to make a battery electric vehicle (BEV) than an internal combustion engine like at GM’s huge production plants. The plant in Lordstown broke ground in May and now the GM/LG Chem joint venture is starting to build the steel factory structure. It will cost up to $2.5 billion.
Moreover, the deal with LG Chem is sort of like Tesla’s deal with Panasonic, but not quite. For example, GM is going to make the battery packs and LG Chem will make the batteries. However, Tesla buys the batteries from Panasonic, which leases space in Tesla’s gigafactory. But with GM, the JV will own the factory and it is not clear who will own the batteries, or if the eventual truck using it will include a royalty to LG Chem.
However, one thing is clear. This plant has the scale to get costs down. It will be able to produce 300 gigawatt-hours (GWh) of batteries. LG Chem is supposed to have 30% or up to 100 GWh online by the end of 2020 (we will hear more at the next quarterly results). Since each EV will have 50 KWh in the battery packs, that amounts to 2 million EVs that could be built using this plant’s capacity. By comparison, Tesla is expected to reach 790,000 EV production capacity in all of its plants, including those in construction.
Further Validation: Tie Up with Microsoft
IMAGE SOURCE: GENERAL MOTORS WEBSITE
Shares of General Motors were higher recently following the announcement that tech giant Microsoft will join a new round of investment in self-driving start-up Cruise. This is a new “long-term strategic relationship” with Microsoft. Here are the key points of the deal:
- Cruise’s autonomous taxis will use Microsoft’s Azure cloud-computing platform.
- Azure will become the preferred cloud-computing platform for General Motors.
- Microsoft will join GM, Honda Motor, and some unnamed institutional investors in a new funding round of more than $2 billion for Cruise.
Cruise’s “post-money” valuation, meaning its valuation after this funding round closes, will be $30 billion, the companies said. There’s no doubt it’s a significant deal for Cruise, and for Cruise’s majority investor, GM. I expect investors will learn more about the deal when GM reports its fourth-quarter and full-year 2020 earnings in early February.
But what can GM’s business be worth? It depends if investors now start looking at GM as an EV and trucking industry supplier. Traditional automotive suppliers trade at higher multiples than the auto makers. Magna International (MGA), for instance, trades at 12x 2021 earnings estimates, while Aptiv (APTV) and Gentex (GNTX) trade for about 36 times and 18 times, respectively. An average supplier multiple would put GM stock at at least double the current share price and that is still without stripping out the value of Cruise!
There might be a quicker way to unlock the value of GM’s technology and increase its valuation towards one of a comparable tech-heavy platform company that has products for its internal consumption as well as third-party customers: separate it from GM’s legacy car and truck business.
RBC analyst Joseph Spak took a stab at the value created by spinning out GM’s tech businesses. He estimates that GM’s electric-battery business could be worth up to $19 a share, while Ultium could be worth up to $13 a share. Stripping out Cruise too (£30bn or at least $15 a share), leaves very little in the current share price ($8 a share) for its base car and truck business, which generates all the company’s profits today. However, management has thrown cold water on this spin off strategy but despite this, there is in my opinion every possibility that the market slowly grows to appreciate what GM is doing and the continued growth of these new technology businesses within the group over time are anyway supportive of valuation upside.
Analysts increasingly see two companies at GM. One is an electric vehicle start-up hiring thousands of software programmers, big enough to sell batteries to other, smaller players. The other is the company still selling gas-powered trucks and SUVs. What would quickly crystallise value is a complete split, but GM President Mark Reuss says that’s not in the cards. Not now, anyway. The company argues that the old company still does well in what political writers call “Trumpistan”. Barra says the new company will also appeal in “Techlandia”, with electrics that hit all price points and are better than gas-powered alternatives. There is even hope of bringing back the dividend that was suspended during the pandemic.
GM is Incredible Value Relative to Tesla et al
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Tesla shares have skyrocketed to extreme levels in the last 18 months because people believe that EVs are the future, and Tesla is the biggest and best EV maker. In reality, Tesla’s entire business is a small fraction of the size of GM’s business. Last quarter, for example, Tesla reported $8.7 billion in revenue and $331 million in profits. The same quarter, GM reported $35.4 billion in revenue and $4 billion in profits. Tesla’s shareholders are paying a high cost for its future via dilutive equity offerings. GM’s legacy internal combustion engine vehicle sales are funding its EV future.
GM has a market cap of just $58 billion. But Tesla has a market cap of $590 billion. That means Tesla is worth ten times the market value of General Motors. On a wider point, what happened to the PE and price of GM stock since I bought them is a perfect illustration why a blind focus on ‘low PE’ as an investment approach is misguided. When I bought the stock three months ago, they were trading 50% lower in price and on a forward PE of 17x. With another earnings report out of the way, material earnings upgrades as people see recovery is coming through and looking ahead a bit further means that despite the price action, the shares now trade on 9x PE!
So far, analysts are not incorporating any material kind of EV premium to the GM stock price. It has also returned to profitability in 2020. The average estimate for 2020 EPS is now $4.60. This puts GM stock on a very low P/E ratio of 12x times. By comparison, Tesla trades at a 360 multiple of earnings for 2020. That is almost 30x times more than General Motors’ valuation.
Another way to compare this to Tesla is on a price-to-sales basis. Analysts expect General Motors to make $130 billion in 2020. This puts GM stock on a price-to-sale of 0.42 times. By contrast, analysts expect Tesla to produce $31 billion in revenue by the end of 2020. That puts it on 20x 2020 sales. So, again the discrepancy is almost 20 times over General Motors’ valuation.
You could make the argument that this valuation discrepancy is due to Tesla’s 100% focus on EV production. Analysts see Tesla dominating the new supply chains of electrics and are buying its story of cars being products of technology, not manufacturing. However, GM is moving in that right direction (much faster than the likes of Ford) and has the real world benefits of distribution infrastructure, strong brands and deep pockets which are powerful tailwinds in any head to head fight for market share. In November, GM announced it plans to invest $27 billion on EV and autonomous vehicles through 2025. GM also plans to release 30 EV models globally by 2025. For comparison, Tesla currently has exactly four EV models. Tesla just missed its target of 500,000 EV sales in 2020. GM plans to sell twice as many EVs annually by 2025. Meanwhile, those ICE sales and profits are going to keep flowing in for GM. Tesla may continue to struggle to break even as its regulatory credit sales dry up in coming quarters.
Morningstar reports that the average P/E ratio for GM stock over the last five years was 15.77. If we apply that multiple to its 2021 forecast earnings of $5.77, the stock should eventually be worth $87 per share. You could even argue that it is reasonable to expect it to trade above its five year average given we are in an upswing of economic recovery and more importantly their higher rated EV plans are much more material to the whole group than was the case five years ago.
GM also beat Tesla to the punch with autonomous vehicle technology. GM recently began testing fully autonomous vehicles in San Francisco. This testing involves vehicles without driver monitors in the car. Tesla’s “Full Self-Driving” option requires a driver to stay alert and be prepared to take over at any time. So GM’s technology is fully self driving while Tesla’s FSD is not.
I don’t mean to single out Tesla. Nio trades at 49 times sales. Workhorse trades at 3800 times sales and even fallen star Nikola still trades at 79,000 times sales! Virtually every pure EV stock on the market is trading at extreme valuations. Yet none of these EV stocks have the cash flow of a legacy ICE business to fund their next-generation EV and AV technology. Not only is GM stock undervalued compared to other EV stocks, it’s significantly undervalued compared to its own five year average multiple. All in all there’s no reason why GM stock should still be selling for such a miniscule fraction of Tesla et al and I believe there is every reason to see these ratios change in GM’s favour with positive implications for the share price.
- The risk is mostly in the older company. GM recently agreed to recall 7 million trucks and SUVs to replace their airbags, at a price of $1.2 billion.
- If Tesla price drops massively, there will be implications (albeit far more muted in nature) for GM stock.
- GM doesn’t pay a dividend (though this could change).
- The core business is cyclical and in terminal decline (though it is very cash generative).
- The ‘green’ credentials of the brand are tarnished by association to the legacy business, potentially limiting growth.
You can see GM stock as a glass half full or a glass half empty. The pivot toward electrics is boosting the stock price. But its valuation remains way below that of most much smaller electric vehicle startups.
My bet is that old world cars continue to throw off cash that funds a technology focused makeover of the GM business. But in that bet, we also have the support of near term cyclical economic recovery boosting the number of traditional cars GM sells. CEO Barra insists GM’s other lines of business, like selling GM’s technology to rivals, should make GM a growth stock again. Far more highly valued rivals in the EV space - Tesla and Nio for example - are hoping to grow into what GM is today maybe 10 years down the line. Both companies are struggling to turn a profit. Both companies are diluting shareholders by repeatedly raising capital. Meanwhile, GM’s business is a cash cow, and its valuation is dirt cheap.
Despite the recent mega rally, GM remains undervalued on almost every criteria and therefore the rerating has further to go. I believe EV technology has great growth prospects but famous EV stocks like Tesla and Nio are potentially dangerously overvalued. In the long term, great fundamentals at decent valuations usually win out in terms of great investments. GM stock is an EV play that provides long-term exposure to next-generation auto tech at an extremely low valuation.
*Disclaimer: This information does not constitute any form of advice or recommendation by Pynk One Ltd. and is not intended to be relied upon by users in making (or refraining from making) any investment decisions. Appropriate independent advice should be obtained before making any such decision. Returns may increase or decrease as a result of currency fluctuations. *
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Past performance is not an indication of future results.