In early November, General Motors (GM 3.82%) stunned Wall Street by reporting an unprecedented $5.3 billion adjusted operating profit for the third quarter. Adjusted earnings per share reached $2.83, up about 65% year over year and more than double the average analyst estimate.
GM earned its entire profit in North America last quarter, driven by a rebound in auto demand -- especially for high-margin full-size pickups -- and high auction values for used cars coming off lease at GM Financial. The same factors will likely lift the General to another strong profit this quarter.
Truck market fundamentals remain strong
Demand for pickup trucks has been red-hot all year. That trend shows no signs of slowing. Indeed, whereas recessions typically undermine the housing market, record-low mortgage rates and a sudden desire for space have combined to drive a huge jump in housing demand. The volume of home sales and the median price have both been growing by double digits year over year in recent months.
That in turn has encouraged homebuilders to get back to work. New housing starts have almost recovered to the peak level seen in January. Housing starts typically correlate well with demand for pickups. Sure enough, sales of GM's full-size pickups -- the Chevy Silverado and GMC Sierra -- declined just 3% year over year last quarter, despite incredibly low inventory levels.
This quarter, GM has the additional advantage of segment-leader Ford Motor (F 2.31%) going through a transition to its next-generation Ford F-150. Ford built an average of fewer than 20,000 F-150s per month in October and November because of downtime and lower initial production rates for the new models. That's less than half of normal levels, and it has aggravated existing inventory constraints and started to weigh on Ford F-150 sales.
The combination of low inventory levels and strong demand should enable manufacturers like Ford and GM to keep discounts modest for their full-size trucks. That will support profit margins.
Finally, GM has plenty of room to rebuild its pickup inventory in the quarters ahead after dealer stocks hit critically low levels in June. This will support high production rates, which ultimately drives profits in the auto industry. In fact, this will be the first full quarter that GM benefits from boosting the workforce at its Fort Wayne truck plant, which will reportedly allow it to churn out an extra 1,000 full-size pickups every month.
Used vehicle values remain high
Another key driver of GM's big Q3 profit was a record $1.2 billion pre-tax profit at GM Financial. A spike in used car auction values allowed GM Financial to earn windfall profits selling vehicles coming off lease. It also allowed the finance subsidiary to take smaller losses on repossessed vehicles sold at auction. And federal stimulus measures helped keep payment rates high, reducing the need for repossessions in the first place.
These tailwinds tapered off in the fourth quarter, but only by a bit. While used vehicle auction values have been declining sequentially since August, auction values are still well above year-ago levels. That points to GM Financial once again ringing up big profits from selling off-lease vehicles.
Furthermore, the new stimulus bill calls for another round of direct payments to Americans that could come as soon as next week. That will help people stay current on their auto loan and lease payments.
Another surprise may be on the way
In early November, General Motors provided new guidance implying that it would generate an adjusted operating profit between $3.2 billion and $3.7 billion this quarter. That would be a good deal worse than its Q3 performance, but better than what the General has delivered in recent years during Q4, which tends to be a seasonally weaker period. Analysts on average expect adjusted EPS of $1.91.
However, strong full-size truck production and the continuation of favorable conditions in the used vehicle market make these estimates look conservative. I expect GM to deliver another earnings beat when it reports its Q4 results in February. That will give it strong momentum heading into 2021.