Automakers have faced numerous challenges over the past three years. When the COVID-19 pandemic hit, demand plunged and most auto factories had to close for two months or more. Then demand recovered almost overnight, forcing automakers to ramp up production rapidly. Before long, supply chain disruptions -- particularly a global semiconductor shortage -- began to wreak havoc with output. Soon thereafter, commodity costs surged. And now, inflation, rising interest rates, and the threat of a recession pose a threat to demand.
As a result, investors have lost patience with auto stocks like General Motors (GM +0.65%). GM stock has lost 45% of its value year to date. However, General Motors remains highly profitable, making it a great stock to buy in July following this sharp pullback in its share price.
Good news or bad news?
On Friday, General Motors reported that U.S. vehicle deliveries fell 15% year over year in the second quarter. Some models posted big increases as supply improved compared to 2021, but new production disruptions contributed to sharp declines for other models.
Image source: General Motors.
GM also revealed that it ended the quarter with 95,000 mostly complete vehicles in its inventory. It will need to install certain components that were unavailable due to supply chain disruptions before shipping those vehicles to dealers and recognizing revenue. As a result, GM expects quarterly net income between $1.6 billion and $1.9 billion, well below the analyst consensus.
But on the bright side, GM anticipates that it gained market share last quarter, as supply constraints had an even greater impact on some of its rivals. Additionally, tight supply has allowed it to keep incentive spending at historic lows (2.3% of average transaction prices, compared to roughly 13% a few years ago). Most importantly, GM maintained its full-year guidance, as it expects to clear most or all of its backlog of incomplete vehicles by year-end.
Some investors and analysts appear to be frustrated that chip supply constraints are still impacting production. This seems like a tempest in a teapot. The 45% drop in GM's stock price this year looks like a massive overreaction to temporary headwinds, particularly given that the company's underlying earnings forecast hasn't changed.
A bigger bargain than ever
Based on management's projection that adjusted earnings per share (EPS) will come in between $6.50 and $7.50 this year, GM stock currently trades for less than five times earnings. Excluding the company's loss-making but extremely valuable autonomous driving subsidiary (Cruise), the stock is even cheaper.
NYSE: GM
Key Data Points
To some extent, a low valuation can be explained by GM's status as a cyclical business. Automakers' profits typically decline significantly during recessions.
Yet even if a recession is coming, this time may be different. There's a ton of pent-up auto demand today due to the supply constraints of the past two years. And even if demand were to decline, the industry's lean inventory position will enable automakers to stay disciplined about pricing. By contrast, in a typical recession, automakers start with too much inventory and have to roll out margin-crushing discounts to get aging vehicles off of dealers' lots.
In short, GM stock appears irrationally beaten down even assuming that a recession is right around the corner.
The future is bright
General Motors' lucrative truck and SUV franchises are likely to continue churning out massive profits for many years to come. Meanwhile, the auto giant is investing aggressively to develop a slew of electric vehicle models, along with cost-efficient battery technology. That will position the company to remain an auto market leader for decades to come.
Investors should recognize that the auto industry is chock-full of risks. Volatility in commodity costs, demand shifts, manufacturing quality issues, and technological change could all potentially impact GM's future earnings.
However, General Motors has successfully navigated pressures like these repeatedly in recent years. That makes GM stock look like a fantastic buying opportunity at $32.
