As the COVID-19 pandemic spread like wildfire earlier this year, shares of automakers plunged. Investors fled the industry during the broader market sell-off and never fully returned, worrying that the economic impact of the virus would crush auto sales, undermining automakers' profits and cash flow.
General Motors (GM -0.94%) was no exception. GM stock traded for more than $40 last summer -- prior to a six-week strike by its U.S. production workers -- and around $35 as recently as mid-February. However, the stock briefly plunged as low as $14.33 in mid-March. While it has recovered somewhat since then, GM shares still trade for around $25, far below their 52-week high.
The weak stock price doesn't make much sense in light of GM's solid first-quarter results and improving market trends in recent months. That's why I bought more GM stock last week.
Industry sales stabilize
Notwithstanding a sharp drop-off in sales during March, General Motors reported solid U.S. delivery figures for the first quarter of 2020. While total deliveries declined 7.1% year over year, deliveries of high-margin full-size pickups surged 28% year over year. Strong truck demand drove double-digit year-over-year growth in GM's North American operating income for the quarter.
That said, U.S. new vehicle sales plunged to a seasonally adjusted annual rate of 8.6 million in April: about 50% below the typical pace of the past five years. Additionally, GM and other automakers were forced to suspend domestic production beginning in mid-March. These factors provided some justification for the sharp drop in GM stock.
Yet demand bounced back quickly. The annualized sales pace surpassed 12 million units in May, and most analysts believe the annual sales pace has reached approximately 13 million this month. Pickup demand has been especially strong, leading to supply shortages. A surge in new-home sales last month bodes well for the future, as the housing sector is a big driver of full-size truck demand. If the pandemic increases demand for single-family homes as opposed to urban apartments, it could provide a long-term boost to pickup sales.
Meanwhile, GM partially restarted production in North America on May 18. At the beginning of June, it ramped up to three production shifts for all three of its U.S. pickup assembly plants. Several plants that build crossovers added back a second shift at the same time.
This isn't to say everything's perfect. Last week, GM eliminated the third shift at a Tennessee plant that builds several Cadillac and GMC crossover models, citing weak demand. And annual auto industry sales of 13 million units would be well below pre-pandemic levels. However, cyclicality is a fact of life in the auto industry, and General Motors can produce roughly breakeven cash flow globally even with U.S. industry sales at this level. As demand returns after 2020, free cash flow should recover, too.
Promising signs for GM Financial
GM's financial division looked like another big source of risk in the early days of the pandemic. After all, GM Financial has over $80 billion of auto loan receivables and leased vehicles on its balance sheet. In theory, that could have exposed it to billions of dollars of losses if consumers defaulted on auto loans en masse due to surging unemployment and used car values plummeted due to rising supplies and weak demand.
In April, payment deferrals within GM Financial's North American retail loan portfolio rose to 3.5%, compared to normal levels of 1% to 2%, while realized residual values fell below book value (implying losses on a typical used vehicle sale). Bears' fears seemed to be coming true.
Yet after plummeting in April, used vehicle prices have surged 16% over the past two months, reaching a record high in June. The used vehicle supply contracted for a variety of reasons, and demand has remained solid, partly because production shutdowns led to shortages of some new vehicle models. High used vehicle prices will allow GM Financial to start booking gains when it sells vehicles coming off lease.
The jump in payment deferrals also likely overstates the risk of losses from the loan portfolio. Generous temporary unemployment benefits and a recent rebound in employment should enable most of GM Financial's customers to start making payments again.
A deeply undervalued stock
Prior to the late-2019 UAW strike and the COVID-19 pandemic, GM's annual adjusted earnings per share had consistently exceeded $6 for several years. For the past couple of years, that has included significant losses from the company's self-driving technology subsidiary, GM Cruise, which is worth about $10 per share based on its most recent external investment round. This makes GM stock look extremely cheap at around $25.
EPS probably won't go back to $6 next year. But with demand holding up well in the high-margin pickup segment and cost savings from GM's recent restructuring efforts already flowing to the bottom line, it won't take long for General Motors to start churning out big profits again. GM stock isn't likely to stay down for long, either.