In Defense of Detroit
Car companies can’t catch a break. On Monday Tesla Inc.’s market capitalization surpassed that of Ford Motor Co, even though the latter sold almost 90 times as many vehicles last year (and made a profit).
Shares in Ford, Fiat Chrysler Automobiles NV, and General Motors Co fetch between 4 and 7 times their estimated 2018 earnings. German industry royalty BMW AG and Daimler AG only trade on about 8 times.
Buying Tesla stock would cost you about 190 times its estimated 2018 earnings. Yet Tesla will probably lose money this year, as it’s done every year since 2007, according to Bloomberg data. Chief executive Elon Musk mused on Twitter that “Tesla is absurdly overvalued if based on the past, but that's irrelevant. A stock price represents risk-adjusted future cash flows.”
I won’t dwell on the riskiness of those cash flows (or their absence right now), but do read my Gadfly colleague Liam Denning here and here. Still, Musk is right about how a company's value is calculated. It just begs a question: while everyone's buying into Tesla's rosy prospects, is Detroit’s future really so bad?
I'm not asking out of nostalgia for gas guzzlers. I’ll be glad to see them go. Still, investors are overlooking the industry’s impressive earnings and cash generation and the possibility these things aren't about to go up in smoke. They also underplay the difficulties of building a car company. Apple Inc. and Alphabet Inc.'s Google haven’t made much progress.
Others find the valuations puzzling too. Hedge fund billionaire David Einhorn was panned last month for proposing a GM stock split. Yet his broader point -- that GM isn't getting credit for decent profits and dividend yields -- was spot on.
When they’re not panicking about the shift from combustion engines to electric motors, or driverless car pods, autos investors are fretting about autos loan books and diesel’s demise. These are era-defining challenges, of course. But carmakers seem to be coping so far.
Forced into bankruptcy protection and restructuring in 2009, GM has since generated about $25 billion in free cash flow, according to Bloomberg data. Analysts expect that to swell by another $10 billion in the next two years. Fiat Chrysler promises similar.
Carmakers have been helped by the popularity of high-margin SUVs, while China generates rich returns. But the industry has also been managing costs better. You'd have been laughed out of the room three years ago if you'd predicted a 6 percent operating margin at Peugeot SA.
True, the U.S. market has probably peaked. Ford's sales fell 7 percent in March compared to a year ago. Yet sales might not fall off a cliff. "If rates stay low, employment remains solid and the consumer remains confident, car demand can hold up," notes Max Warburton at Bernstein Research.
Even if earnings falter, industry balance sheets are much stronger now. Volkswagen AG can cope with a dieselgate bill of more than 20 billion euros. BMW boasts almost 20 billion euros in net liquidity, meaning it shouldn't be hobbled by car finance or diesel woes. There will be cash left over to fight back against Tesla.
Musk is fortunate that investors applaud when Tesla asks for more money. These double-standards aren't going to go away. But neither is an industry that's been around more than 100 years.
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