EUR 850.00 For Business Accounts Only

Morningstar | Light Trucks Drive Strong Pricing to Offset Higher Commodity Costs in GM's 3Q

We are not changing our fair value estimate after GM reported a good third quarter that crushed market consensus. Adjusted diluted EPS rose 41.7% year over year to $1.87, easily beating consensus of $1.25, while revenue grew 6.4% to $35.8 billion versus consensus of $34.9 billion. We've talked about the importance of GM's product cadence favoring light truck models since last year's launch of new generation crossovers. This year it's a new generation of full size pickups and more Cadillac crossovers with the XT4 and soon the XT6, the Chevrolet Blazer in 2019, and 2020 brings new generation full-size SUVs such as Tahoe and Escalade based on the T1 truck platform launched this year.

The new pickup launched in August, along with last year's crossovers being fairly new, enabled robust pricing. GM North America had third-quarter record average transaction prices with U.S. prices over $36,000 thanks to demand and about $500 less in incentive spending per unit. GMNA adjusted EBIT margins rose 190 basis points year over year to 10.2% and its EBIT grew 37% to $2.8 billion. This growth enabled GM's total company adjusted EBIT to rise 25% to $3.2 billion, as $1.7 billion in volume and pricing tailwinds easily negated a $400 million commodity headwind and a $500 million currency headwind mostly from Brazil and Argentina. Also encouraging is the roughly $600 million of pricing contribution from carryover product, such as the crossovers, as this metric is often negative, a good sign for fourth quarter.

We expect fourth quarter results and cash flow to be strong. Management cut 2018 adjusted diluted EPS guidance in July to a range of $5.80-$6.20 and said to expect about $6. They now guide to the high end of the range and think upside beyond $6.20 is possible, as do we because of light trucks. GM has only repurchased $100 million of its shares this year so with automotive cash at Sept. 30 at about GM's $18 billion target level, we hope GM buys back its cheap stock soon.

GM Financial continues to show why GM has upside valuation potential. The captive finance arm's adjusted EBIT is up 65% in the first nine months of 2018 and annual EBIT run rate is about $2 billion. Charge offs through the first nine months of the year are down 10 basis points to 1.8% of average retail finance receivables as the lender continues to move away from its subprime origins. GM Financial was created in October 2010 when GM acquired subprime auto lender AmeriCredit. Retail delinquencies over 30 days in the quarter declined by 40 basis points to 4.8% and the lender financed 50% of GM's U.S. sales compared with 36% in third quarter 2017. GM Financial is progressing better than expected in terms of its leverage ratio so management announced the unit will pay a fourth-quarter dividend back to GM of $375 million. Management expects this dividend to be annual and perhaps as soon as 2020, all the captive's net income will be paid to the parent as a dividend.

With more upside coming in the U.S. from new products such as trucks, Cadillac, and the Chevrolet Blazer, equity income this year (mostly from China) is holding steady from 2017 levels at about $2 billion thanks to Cadillac's Chinese volume up 20% so far this year, more GM Financial growth over time, and management still expecting to launch Cruise's AV ride hailing service next year, we see many reasons to like GM's stock right now. Sentiment, however, could hold the name back given we are late cycle in the U.S. auto industry. If GM continues to impress the market with cash generation next year, then that may be enough to boost the stock nearer to our fair value estimate despite fears of a U.S. slowdown. The dealers we spoke to during third-quarter earnings indicated higher U.S. interest rates are not causing consumers to hold off buying a vehicle, so GM's new light truck models are well timed. U.S. industry auto sales each month are nearing 70% light truck models and GM's U.S. mix runs higher than average at about 80%.