GM - A Joe's Pros Interview

Joe

Good afternoon, it's Joe DeMatteo here on November 12th, 2021, and welcome to the Joe's Pros interview. I understand you'd like to talk about your bull case on General Motors (GM). I’ll just add that we've talked about this for a while and GM is now trading toward recent highs. 

Pro

Yeah, Joe. It's my fault that we didn't do this a couple of weeks ago, but we think this has so much upside that it really won't be relevant if we're right. So, GM is an interesting story. We got involved a little while ago. It's a name that we've known for many years, obviously, but we think that the core business has actually gone through a massive transformation post-bankruptcy. Much more importantly, they’ve pivoted the company to position themselves as a winner in the EV space. While it might not be quite as attractive as Tesla or Rivian, we think that this is a fantastic business trading at a very big discount relative to its assets and potential. It's still being valued today as a traditional, highly cyclical auto OEM despite the fact that it's completely transformed its business post the Great Recession. As the North American auto market normalizes, I think the earnings power of this business will become very evident. It's much better than it was before and something that we haven't seen since this management team really took over. ​

Mary Barra stepped in four or five years ago and has rebuilt the entire company. Since the Great Recession, a couple of things have happened post-bankruptcy. First of all, they got rid of most of their pension liabilities. They still have some, which we back out of our valuation. It used to be $50B but it's been reduced to about $16B. We discount that a little bit for time value of money but we hit them for that on their EV. They got rid of their European operations, which were Opel and Vauxhall, which were money losing. They exited from Australia and New Zealand. They reduced the number of brands and nameplates. They closed Oldsmobile and Pontiac. They established a four-year contract with the UAW in late 2019, and they meaningfully restructured and reduced their North American manufacturing footprint. This is a very different business than what you would have even seen five years ago. 

So, the way we think about it is that management has talked about reaching an adjusted EBIT breakeven at a North American SAAR number of 10MM - 11MM cars. Pre-COVID, we were kind of at 17MM to give you a flavor for where they could be. Their global free cash flow breakeven is at about 13MM US SAAR. This is a much more profitable company than it was once we get back to normalization. The evidence of this really is in last year, they had a quarter where SAAR was 11MM and they were essentially breakeven, so we don't think this is sort of like management blowing smoke. This is a real number that we're really excited that they can deliver, and I think you're going to see a lot of upside as SAAR starts to tick up. Recently, it's been as low as 12MM. It's kind of bottomed here post-Delta, 12.2MM - 12.3MM, and we think that over the course of next year it gets back up to 15MM - 17MM. But this is not really a call on SAAR. It's more to say that there's a lot of operating leverage in the business. 

They cleaned up the balance sheet pretty dramatically. I'll just quickly go through some of the valuation numbers. They have about 1.47B shares. The stock price is in the low-$60s now, so that's about a market cap of just under $90B. They actually are net cash, but just so you know, they have about $17B in debt. We give them about $12.7B in pension and we back out the cash that's associated with the financial arm. We net that out and we come up with an EV in the mid-$90B range. That's the way we think about it and we'll explain how we think of valuation in a little bit. 

GM is really tainted. When you bring up GM, everybody thinks of the old school. When it was first presented to me, I almost just wrote it off and didn't even look at it because it really was the global all things to everybody. They have every single brand of car, they never shut anything down, they weren't very efficient, they were in every geography, and they tried to be everything to everyone. What's happened in the last handful of years is that they've really focused that down. Now what you can see is that they actually barely have an automotive business in the US, they got out of Europe, and the most profitable business is the North American truck business. This is a much better business in that it's professionally driven, with about 60% of the pickup sales to professionals or tradesmen. Demand should be much more consistent than a consumer business where there's an ability to defer purchases. We think that business alone can do $10B - $12B in adjusted EBIT. 

What's really exciting to us, though, is several years ago before all the hype they really stepped into EVs. They've made very public statements. I’m sure many of the listeners will know that they've decided that they're going to launch into EVs being vertically integrated. Cadillac is actually not going to introduce any new models that aren't EV and they announced that they were going to launch 20 EVs by 2023, starting with the Hummer this quarter and the Cadillac LYRIQ, which will launch early next year. Both of those are sold out. This is a very typical strategy-- start at the high end. You can still make a margin on that and start to develop the products, and then push them down to the lower end. Everybody's following this model, whether it's Tesla, Lucid, or Rivian, so it's a pretty standard roadmap right now on how to get into the EV market. But what we like about them is this was not a knee jerk reaction as we think some of the other auto manufacturers have done. They've thought this through very carefully. They have a battery JV with LG and their battery is actually pretty impressive. There's a significant reduction of about 70% of the cobalt content and meaningful reduction in nickel content. That reduces some of the supply bottlenecks people are worried about. It's a modular approach. These are stackable batteries versus some of the cylindrical designs, and they can actually supply all of their EV demands, but also for other OEMs, as well. They've actually signed a deal with at least one so far, and we anticipate there will be more there. The design ranges up to 400 miles right now, and we anticipate that's going to go up, so we think that they're competitive on that. They've said publicly that they expect to reach $100 per kilowatt hour, which is the crossover point where it's really competitive with ICEs by mid-decade. So, they're on the path with everybody else to get to that breakeven point where it's going to be much more attractive to buy EVs. 

As I mentioned, they're going to bring 20 vehicles to market by 2023. The idea is that they're going to target about 1MM in annual sales by mid-decade. So, this is not just a pie in the sky where by 2030 we're moving over, but this is actually real financial benefit in the near term. 

They've also set up a JV with a charging network, EVgo. That's going to go from about 1,400 charging stations to 4,000 by 2025. There's just been some public announcements about that, so this isn't going to be one where we can't build out the infrastructure and it's not there when they build the cars. Just as a comparison, Tesla has about 2,000 chargers, so this will certainly provide significant coverage around the country and remove some of that risk that I think some people think about. Tesla is obviously the leader and VW is pretty far ahead in terms of what they're doing, but beyond them I think GM is very well positioned and they have a very good position in China, as well, which is obviously in an EV market. 

Why is this important? The way we look at valuation is really on a sum-of-the-parts basis. Historically, GM has traded at 0.25x - 0.35x revenue. That's typical for a cyclical industrial company that wasn't too well run. And then if you look at EV companies, Rivian aside, let's just look at Tesla, the most mature one, which trades at about 12x - 15x forward sales. We use about 4x revenue, so it's not like we're saying this is Tesla by any means, but we do think there's a much higher valuation if you can show that you're going to be one of the top EV producers in a couple of years and be able to maintain your share. There's a couple of other things we think are interesting that we value a little bit separately. As I mentioned, they have a financial arm. We actually value that at below book value, so we're handicapping that. That’s not a massive driver but it does drive a couple of bucks per share. They also are a major investor and owner of Cruise, which is the self-driving technology. There's only two real competitors. Cruise and Waymo are the most legitimate ones. There was a valuation round done earlier this year at $30B, and so that's about $14 per share if you look at their pro-rata ownership of that business. We think it actually could be even higher as it is one of the few out there. That'll obviously come to fruition as they proliferate that business. 

Putting that all together, we think core auto EPS could be $7 - $8 per share. It’s $21B - $22B in EBITDA. This thing is trading sub-5x EBITDA. Even for what it was historically, that would be an attractive valuation, but they cleaned up both their balance sheet and their P&L and they generate cash. But then if you think of it in terms of shifting this business and that 20% of their revenue is going to come from EV in a couple of years, you can see how this is going to get rerated pretty dramatically. When we do the math, we can very easily get to well north of $100. We have a $106 starting price target, and that values Cruise as it is (~$14 per share), and it suggests that 80% of the business trades at the 0.35x revenue and 20% trades at 4x. That's on 2023 consensus numbers and we think that only goes higher as you move forward. Obviously, 4x revenue for an established EV company only goes up. And if you look at it on an EV/EBITDA basis, every turn adds another $13 - $14 per share. So, while it has rerated from the mid-$30s and has broken out to 52-week highs, we think the next two years are going to prove a couple of things: that the core business is actually very profitable and more profitable than people might be attributing to it, but then equally as important, this EV business as they launch these products and can show success could get a higher multiple and we think that they're primed to do that. 

Just as an aside, we spend a lot of time looking at management teams-- what they say and what they do. When we look at our portfolio, this by far has one of the best management teams we have. You might think that's a little ridiculous since it's an auto company and ask why it hasn’t rerated even more. The answer is that it's a tough industry. They were given an interesting set of assets they had to turn around. This is a thoughtful, methodical approach that they've taken, and we think that they've made some really good strategic decisions to put themselves in this place, and now the next couple of years are where the proof is in the pudding. We've already gotten comfortable that the core business is good, but now as we see the Hummer and the LYRIQ rollout and they introduce the next set of products, we think that's going to be critical and that's what we think drives the rerating. I think in the near term, one of things that hit the stock was the SAAR numbers rolling over because of Delta. And, they also had this issue with the battery recall, which they actually recovered most of from their partner, so they structured their contract well, but that did cause some noise in the marketplace as people were thinking about it. But again, we're not sitting here looking at this saying, “Hey, this is some pie in the sky dream stock.” This is something trading at less than 5x normalized EBITDA and we think has dramatic upside and has some hidden gems like Cruise and even some other aspects where they collect a lot of data from their OnStar system and can monetize that. They've even talked about setting up an insurance arm. So, we think there are many ways that this is going to get monetized over the next several years. 

The biggest risks are obviously if SAAR rolls over, that just creates a headwind for them. That will hurt the near-term performance of the stock. Obviously, the EV space is competitive. We like their battery technology, but you never know when someone else might come out with something better and it is a bit of an arms race here. But we think they're well capitalized and positioned well for the future. So, that's how we think about this. We think it's just the beginning of hopefully a very long ride for these guys. 

Joe

Thank you for that. In the SOTP, do you think about the joint venture on the batteries? Can you talk a little bit about that and do you think about that as part of the SOTP? 

Pro

We actually don't even break that out. That's what we think is kind of intriguing here. We just kind of built into their cost structure the way that that gets monetized, but there could be more value to that. We haven't done enough work to figure that out, but we do think that that is a potential upside. Cruise we do specifically break out because there is an independent valuation of that and there is independent valuation of Waymo, as well, so we think that's a much more clear piece of value. We hesitate on the battery side because we haven't seen that yet, so we don't want to break that out in that way. 

Joe

How many customers do they have? Have you done a lot of work on the actual independence of it versus the internal needs? 

Pro

Right now, I believe Honda is the only announced external customer that they've signed up, but I'd have to check if they've signed up others. It really was set up for their own use. What they wanted to do was avoid supply constraints. That’s the problem with a lot of these companies that don't make their own batteries, and Tesla faced the same thing, that's why they partnered up with Panasonic. They needed to make sure they had battery supply. So GM, unlike Ford, went out and said, “We need to lock up battery supply and basically build a JV. And by the way, it's a good enough battery that we can sell it to others and we have enough capacity,” but it really was to lock down their own supply chain. That was the main strategic reason.

Joe

And going back to Cruise, how much detail have you done on Cruise and how long ago was the $14 per share valuation? You seem to be carrying it forward, so if it's successful, I imagine there's upside. 

Pro

January 2021. That was valued at $30B in aggregate. Their portion of it was about 70% of that. That was a January 2021 round, so that is sort of an independent valuation. When we look at Waymo, Waymo was also valued at around $30B early in 2020. I don't know how that’s changed, but there have been some pie in the sky estimates that have said these are worth $100B each. I hesitate because that's not my realm of evaluating where it is, but if you believe in self-driving cars, if you believe that every Amazon truck is going to be self-driving and every truck going across the country is going to be self-driving, this has a lot of upside. We're just using valuations we know were crystallized in the last year. 

Joe

And on a competitive basis, how far under the hood have you felt confident to look at on Waymo vs. Cruise vs. any other competitors that are out there? 

Pro

They are the two clear leaders. That's definitely been established. I think you can build a pretty big moat around it. If you look at who they're working with and so forth, it was pretty obvious that these are the two winners and it's going to be hard to break into it. There's no reason for this to be replicated by a lot of people and you get smarter as you build your data. We think there are some pretty big moats around this and it's been validated by the contracts they have. Beyond that, it's not like I've actually compared them personally. 

Joe

I noticed that Berkshire was a large shareholder. Has that been a decade long? 

Pro

That’s a good question. I haven't tracked what they've done. But what was actually intriguing to me is if you pull up the chart from like 2012, the stock basically traded in a range from like $25 - $35. Then it obviously got hit with COVID, but that was also when people could see the leverage that they had in the model and they started coming out with some of the EV stuff, and now it's breaking out of that range. This is a hard one to get rerated. It's not dissimilar to another company that we're invested in, KBR, where it had a legacy business, everybody has a perception of it that it’s a cyclical that's been around forever and not particularly well managed. They got saved in the Financial Crisis but where are they now with all these other exciting new car companies? But when you dig under the hood, they've put together this set of assets that we think is actually unique. And the fact that they already have the footprint-- they don't need to build out locations to sell this stuff. They're building out the charging stations, obviously, but beyond that, they've got it. They've got the brand names, they were smart enough to lock up the battery capacity, they have their own auto driving capability. They've done all the things you want to do that take time to build. You can't do this overnight. Even Tesla couldn't build a battery supply overnight, so we think they've done the right thing. One of the risks that we worry about in the near term is they're launching their products for the first time now. They do have some EVs in China, but the Hummer and LYRIQ are going to be flagships, so you’ve got to see those launches go well. Obviously, they're sold out, but you want to make sure that they're good cars and that they can compete because the competition in the next three years is going to get much more heated. 

Joe

That’s a good place to jump off into a little bit of a discussion around the charging stations. Do the Hummer and LYRIQ both have 400 mile ranges? 

Pro

The battery itself has a 400 mile range, but that's more for cars. I think these initially will be launching with about 300 miles of range is my understanding. 

Joe

And then there's people using this for longer commutes. From my conversations, I've heard that a lot of Tesla owners feel pretty comfortable doing those long trips. What's the status of that buildout for GM? 

Pro

EVgo has about 1,400 charging stations but they just put a press release out where 2,000 are already cited and getting developed. I think within a year, you're going to see well over 3,000. Tesla's got a little over 2,000, so I think the coverage will be comparable. I do think this is a moving target. It's only going to get better. The question is whether it’s early enough. I would say as long as they have this well-established by mid- to late-2023 where people aren't really worried about it and you're not coming up to these charging stations and they're full or they don't work at the capacity that you think they work, that should be fine. I do take some comfort in that everybody but Tesla is pretty motivated to get these stations up and running. I think even in the infrastructure bill, there's some allocated to building out charging stations. Putting all that together, I don't worry about that much at all. I think right now if you went and tried to drive cross country, it would be a little more challenging in a non-Tesla, but in a year and a half, that's not going to be an issue. 

Joe

I happen to know that you're a Tesla owner. Are you going to switch? 

Pro

That's a great question. I have a 2016 Tesla. It's the best car I've ever had. The day I sat in it, it was just obvious to me that this is the way the world is going to go. Having said that, it's taken a while and it's taken a surprisingly long time for the OEMs to get there, partly because they had to build up the technology, partly because they're also playing defense. I think we've now crossed the rubicon. Everybody's seen where the world's moving. What I'm excited about is, I think within two years you're going to see so much more competition in general. Someone like GM can launch 20 EVs in 2023. They're going to address a big part of the market. But will I switch? I'm going to see which is the better car, quite frankly. I love my Tesla, but the fit and finish is not great. So, would I look at the Porsche? Would I look at the LYRIQ? I will, I'll look at all of them. I think what's great for the consumer here is you're literally going to have 100 cars on the market in 2023 - 2024. You're going to have much more choice and pricing is obviously going to come down, so I feel like we're in that sweet spot where the proof is going to be in what they deliver and we'll have to see how the quality of the car is. 

Joe

Is charging a Tesla like charging an iPhone and charging everything else-- the Porsche, the GM, etc.-- is that going to be like an Android in that sense? Or is everything compatible except for the Tesla? 

Pro

Everything is going to be compatible except for the superchargers, so I think that's a good analogy. What is interesting, though, is the charging of the Porsche is actually faster if you have a higher capacity of their battery. That's kind of their selling point. I forget how much they could charge in 15 minutes-- I think they can get a 75% or 80% charge in 15 minutes vs. the Tesla which takes about a half an hour. I think that's also going to just keep accelerating as battery technology and the charging capacity goes up. We'll have to see. Right now I rarely use a supercharger because I just don't need to use it that often. I charge it every night at home, which is fantastic. I never have to just stop to do it, but when I do, it does take me about 20 minutes to charge the Tesla up to where I need to go to get to the next spot. I think as that gets down to 10 minutes, that's really the same as just going to get some gas, and that's when nobody will care about it. 

Joe

What are your actual EPS numbers vs. the Street, and are there any meaningful differences on earnings, cash flow, etc. over the next two or three years? 

Pro

Yeah, the main number I focus on is that we think in a normal 16MM - 17MM SAAR environment, with a cyclical like this that has historically traded on SAAR, we kind of try to figure out what normal 16MM - 17MM SAAR earnings are. We have $7 - $8, current expectations are about $5. So, I think that you're going to start to see that leverage in numbers going up if you get that SAAR. Now, the tricky part is, are we going to see that SAAR number next year? Probably not until the end of the year as things kind of normalize with the supply chain, but we think that's where you're going to start to see the differential is really towards the end of next year. That's the real difference. We use about $21B - $22B as kind of a normalized EBITDA, and that's basically mostly on the core auto business. 

By the way, I will put a plug in. You should go look at the Hummer. They have a video about it, so just go look at the video for the Hummer EV. It's pretty cool. And if you think about it, the concept there was that the Hummer basically got stopped because it was just so ridiculously inefficient and it was this massive vehicle. Getting a Hummer EV is kind of like, “Hey, if we can do it with a Hummer, we can do it with anything. The LYRIQ actually has a pretty cool commercial. You should see that one, as well. I think Will Ferrell did the LYRIQ in a Super Bowl commercial, so you should take a look at those. They're pretty good. 

Joe

Good stuff, will do. You’ve been super generous with your time. Did I forget anything that we need to say?

Pro

No, I think that's it. We're investors for the long run, so we think 18 - 36 months out, and we think that the road map here is pretty clear. There's all the COVID, inflation, and supply chain caveats, but when we look at this company a couple of years from now, we think it's a dramatically different looking company and that people will understand the earnings power here and how they're positioned for the next decade as they start to roll out those models. 

Joe

Right. OK, thank you so much and enjoy the weekend.