Six months ago, investors worried that the COVID-19 pandemic would be disastrous for General Motors (NYSE:GM). Shares of the top U.S. automaker lost half of their value between the beginning of 2020 and mid-March, due to fears of a huge slump in auto sales and big losses in the company's GM Financial subsidiary.
These concerns proved to be vastly overblown. While GM lost money in the second quarter, its financial results were much better than what analysts had expected. Now, the General is poised to return to profitability in the second half of the year, and recent data points hint at strong earnings potential for the next few quarters.
Resilient pickup demand
The first positive sign for GM is that demand for full-size trucks remains incredibly strong. Last quarter, combined deliveries of the Chevy Silverado and GMC Sierra declined just 12% year over year, despite exceptionally low inventory. GM's full-size truck inventory in North America bottomed out at 87,000 units in early June, compared to 270,000 units at the end of June 2019.
Management noted that full-size truck inventory rebounded to 120,000 units by late July. However, dealers have been selling full-size trucks as fast as GM can build them. As a result, the supply of GMC Sierras on dealer lots stands at 20 days or less. Chevy Silverado inventory is only slightly higher, at around 26 days supply. Usually, dealers would hold 80 to 90 days supply of full-size trucks, due to the wide range of configuration options available.
General Motors executives say that the pickup inventory shortage is being driven by high demand rather than production problems. That bodes well for profitability. With demand outstripping supply, there's no need for GM to offer huge discounts that would cut into margins. The company has also shifted supply (particularly for the GMC Sierra) to the more profitable crew-cab models.
Additionally, between meeting current demand and rebuilding dealer stocks, GM will be able to run its full-size truck factories at full throttle for a long time. On Sept. 1, the automaker stepped up the production rate at its Fort Wayne Assembly facility, allowing it to build an extra 1,000 pickups per month.
Full-size pickups accounted for 28% of GM's U.S. deliveries last year and generate a disproportionate amount of the company's profit. As long as GM is building pickups as fast as it can and selling them without big discounts, the company should reliably churn out strong profits.
Used vehicle prices stay elevated
A second good sign for General Motors is that used vehicle prices have remained surprisingly strong in recent months due to buoyant demand. That's important because residual values have a huge impact on GM Financial's profitability, mainly due to the finance subsidiary's big leasing business.
In April, the auction market for used vehicles dried up, leading to low sales and a sharp drop in residual values. However, the auction market came roaring back thereafter. By June, residual values were significantly higher than they had been before the pandemic. Indeed, from June through August, wholesale values for used cars were at record levels.
Despite these strong market conditions, GM Financial has been budgeting for a 6% to 8% year-over-year decline in used vehicle prices in 2020. It has been incurring accelerated depreciation expense based on that forecast, contributing to a 49% drop in the segment's income in the first half of the year.
There have been some signs of normalization in the used vehicle market recently, with prices down 0.9% in the first half of September. Still, prices remain high by historical standards, and the pandemic seems to be boosting vehicle ownership rates (and thus demand). That puts GM Financial in position to reap a windfall from selling off-lease vehicles at higher-than-budgeted prices in the second half of 2020.
Don't underestimate the General
General Motors reported a small adjusted profit for the first half of 2020 despite losing about two months of production in the crucial North American market. Between stellar demand for its lucrative full-size pickups and strong used-vehicle auction values, profitability is set to come roaring back now.
The average analyst estimate currently calls for earnings per share of $1.27 this quarter, down from $1.72 a year ago. While that was an extremely strong result, it still looks like analysts may be underestimating the company's earnings prospects for this quarter.
Barring another big setback in the auto market, the average 2021 EPS estimate of $4.43 also appears conservative. (Between 2016 and 2018, adjusted EPS routinely eclipsed the $6 mark.) GM stock seems to be severely undervalued at just seven times this conservative forward earnings estimate.