Shares of General Motors (NYSE:GM) surged to as much as $45 back in June, after the company announced a $2.25 billion investment in its GM Cruise autonomous vehicle unit by technology powerhouse SoftBank. The deal valued the loss-making Cruise unit at $11.5 billion (roughly $8 per GM share), making the rest of General Motors seem even cheaper.
However, this euphoria wore off very quickly. The main catalysts were GM's second-quarter earnings report, which included a reduction of the company's 2018 earnings-per-share guidance, and a recent slowdown in the Chinese auto market. The net result was that by the third week of October, GM stock had fallen 30% from its June high.
Despite these headwinds, the General reported impressive third-quarter results on Wednesday. It also hinted that its updated forecast may have been too conservative. GM stock surged 9% in response -- and there could be plenty more upside over the next few years.
A massive earnings beat
In early October, GM reported that vehicle deliveries fell sharply in its top two markets -- the U.S. and China -- last quarter. Deliveries plunged 11% in the U.S. and 15% in China. Incentive spending did decline in the U.S., but investors still feared the worst. On average, analysts expected EPS to slip to $1.25 from $1.32 a year earlier.
Instead, General Motors reported blowout results, with adjusted EPS surging more than 40% to $1.87. Some of the improvement came from a lower tax rate, but GM's operating profit (which excludes taxes) increased 25% thanks to margin expansion.
One big reason for GM's strong margin performance was that its wholesale volume (which determines revenue and profit) increased slightly, even as deliveries to customers declined.
In North America, which accounts for the bulk of GM's profit, wholesales jumped 11% last quarter to around 843,000. Higher volume and lower incentive spending more than offset rising commodity costs, driving nearly 2 percentage points of operating margin expansion and a 37% jump in operating profit. While the sharp divergence between wholesales and deliveries may seem concerning, U.S. dealer inventories still ended the period down nearly 3% year over year.
Wholesale volume did decline in China -- but only by 4%. Moreover, most of the market weakness was in smaller cities, where GM's sales mix skews toward cheaper and less profitable models. As a result, GM's equity income in China rose 6% to $485 million -- a new record for Q3.
Lastly, GM Financial benefited from strong consumer credit trends and higher used-vehicle auction values. Segment profit came in around $500 million for a third consecutive quarter, up more than 60% year over year.
The future looks bright
In conjunction with its strong earnings report, GM said that it now expects its full-year EPS to be at the high end of its updated $5.80-to-$6.20 guidance range -- and possibly even higher. Looking ahead, the General has a good chance to grow its earnings and cash flow in 2019 and 2020.
The recent launch of a new generation of full-size pickup trucks is the biggest near-term catalyst. The new models should command substantially higher prices, and General Motors has increased its manufacturing capacity for more lucrative crew-cab configurations. The rejuvenation of the Cadillac brand -- a new model will arrive every six months through 2020 -- should also help. Outside the U.S., cost cuts and the introduction of a new low-cost vehicle platform could drive a substantial improvement in profitability.
GM is also nearing the peak of a recent investment cycle. Capex should moderate starting next year, and GM Financial will be able to return virtually all of its profit to the parent company by 2020, driving a big improvement in free cash flow.
Considering that GM stock still trades for just six times earnings -- and less than five times earnings excluding its Cruise subsidiary -- the potential upside for patient investors is enormous.