It’s hard to make sense of what’s happening in the stock market. There’s no simple explanation to why certain profitable companies can trade at 10x Price-Earnings (PE) or why money-losing companies are trading at 100x. The automobile industry is an example. There has been little appetite for traditional auto makers like GM and Ford. Tesla (TSLA) captures all the electric-vehicle (EV) enthusiasm. Tesla is trading at $930 a share, up 200% in a year and 121% less than two months in 2020.
Below is the market capitalization of some of the main auto manufacturers with total car sold in 2019:
- Toyota Motor: $196b, 10.7m cars
- Tesla: Market cap: $168b, 367,500 cars
- Volkswagen: $90b, 10.9m cars
- GM: $50b, 7.7m
- Honda Motor: $47b, 4.8m
- Ford: $32, 4.9m
- Fiat Chrysler: $26b, 4.3m
How has Tesla surpassed Volkswagen which sells 30 times more cars? How does Tesla’s valuation dwarfs the combined market value of Ford, General Motors, and Fiat Chrysler? Globally, the only competitor Tesla trails is Toyota Motor at $196b.
Of course profits, cash flow, and valuation are important. But in the short-term what matters the most is story telling. Tesla and Elon Musk are pushing are very interesting story: Tesla is the car of the future. They are revolutionizing the car industry and saving the planet along the way. Tesla’s cars are cool and high-tech. It’s a computer on wheels. They are a status symbol. Now compare that story to Ford’s “have you driven a Ford lately?” (I have no clue if that’s still their thing). The point is one car company are making investors excited and the others are not.
The belief in Tesla is cult like. You can throw anything at Tesla and the stock just keeps going up. Just last week there has been a car recall, a SEC subpoena, $2b of new shares issued, explosion in warranty expenses, and yet the market doesn’t care. That’s on the top of losing over $700m in 2019. The SEC revelation, that alone, can spook investors. They check up on company accounting and financial practices and nobody seems to care.
The value of a stock is based on future expectations. In this case, the market believes that Tesla will become the biggest and most profitable car company in the world. Over the long term, the expectation is that revenue growth will translate into growth in profits and free cash flow. The value of any investment is the present value of future free cash flows. The market also believe that Tesla’s rise reflects investor expectations that the company will remain at the cutting edge of technological change in the auto industry.
It’s important to note that growth does not always create value. A company can grow, but if it doesn’t earn above the cost of capital, that growth destroys value. In order for growth to create value, a company must earn returns above its cost of capital.
What’s going on with Ford? It hasn’t been an easy year or five years for Ford. The stock has been an absolute dog for years despite seeing their trucks everywhere. The F-series is one the best selling vehicle every year. They are nice. They are a symbol. They are fun. And they are expensive and very profitable. The upcoming Bronco has a nice buzz around it and the Mustang Mach-E has a big reservation list. Still none of that seems to matter. The stock is around $8, half of what they were a couple years ago. It has a juicy dividend of 7.4%. But…the most important question is will they cut it? The current dividend commitment is $2.4 billion annually and guided $2.4-$3.4b for 2020 in free cash flow. Ford does have a strong balance sheet with a cash position of $22 billion and its liquidity, which includes lines of credit, totaled about $35 billion. Ford has to fund the dividend, its capital plan and a restructuring.
They are in a $11b turnaround that never seems to end. Ford disappointed investors with its earnings and guidance.The current CEO seems to be on the right path despite the never ending issues. He adopted the playbook that other companies, like GM and Fiat Chrysler, are now using which is a larger focus on profitably vs market share. These companies were trying to be everything for everyone and it’s not working.
The car industry is changing fast and Ford is in the middle of that struggle. The last five years hasn’t been good for Ford. The main question is what will the next five be like?
There’s no love for GM. The story here is that GM is an old traditional auto maker, not one that is taking a plunge in the future.
Every year the stock seems to get cheaper on an earning basis, but cash flow ultimately came up short for one reason or another. GM trades for less than 6 times estimated 2020 earnings and Ford sells for 7 times. The comparable figure for Tesla stock is about 88 times. Is 2020 the year for GM?
GM does have a plan for an all-electric future featuring leading-edge autonomous-driving technology with their Cruise division (valued at $19b alone but that’s because of Softbank’s investment, so they probably paid too much like everything else). GM is saying the right things by addressing climate change and decarbonization.
The market gives little credit to the huge amount of cash GM generates. For 2020, it forecast almost $7 billion of free cash flow. At that level, GM stock, trading at $35, would have a free-cash-flow yield of almost 13% (vs the S&P 500 index’s FCF yield is about 3.7% and Toyota of 0.8%).
Something needs to happen. The stock hasn’t done anything since its IPO except the nice dividend of 4.3%. Nevertheless I’m confident in GM.
I don’t have much to say on Fiat Chrysler (FCAU). It’s a favorite for certain part of the value investing community. I know Mohnish Pabrai likes it a lot was an important holding of his for years. I think Sergio Marchionne was a good CEO. He was focused on capital allocation and has a famous presentation on the topic: FCA Presentation – Confessions of a Capital Junkie. Basically the message was the industry has not earned its cost of capital over a cycle and consolidation is the answer. Which explains why he was always trying to sell itself to GM, Ford, and whoever was interested, which confuses me. Spin this, buy that, sell that, split this etc…they are not mergin in Peugeot. Will Americans buy French cars? Peugeot and Fiat trade for just 5.8 times and 4.9 times estimated 2020 earnings because nobody cares.
Fiat Chrysler has some good brands. I think the RAM and Jeep are strong and could be stand alone. But the main problem with Fiat is that they are behind in the EV game and R&D. They are behind in playing catch up.