Autos: GM and Ford Diverge - For Now

Excerpt from Footnotes and Flashbacks: Week Ending Feb 3, 2023

The legacy Detroit 3 always could diverge in dramatic fashion across the cycles, but there is nothing normal about this auto cycle given a combination of factors. The rise of EV investments and related launches is one major aspect of the new beginning for this industry. The test of the OEMs post-credit crisis cyclical resiliency presents another set of theories that will get checked. The breakeven SAAR rates the industry cited after the massive restructuring of 2009 now faces the onerous investment demands of the EV transition. 

The EV capital requirement has given rise to speculation that the EV units of OEMs will get spun off to shareholders. That way, they can be valued on a more speculative set of forward valuation metrics. Then the old school ICE models would stand on their own financial metrics and not be clouded by the heavy expense burden of the transition.

The EV challenges extend from product evolution to establishing the right supplier chain structure for the new vehicles. The new demands for battery production and lithium supply also brings the recycling challenge and the best plan for working with dealers.  The EV education process for dealers and related F&I products and remarketing capabilities for used EVs is certainly not a simple subject. The trade rags are filled with commentary on the challenges for the retail end as well as the product part of the puzzle A to Z.  The theory is that dealers and their capabilities in services and finance are an ace in the hole to combat Tesla and Musk as they move down the price spectrum.

The stock action over various time horizons as detailed above show very solid performance for OEM equities given the backdrop for auto production, which has been more like recession levels than peak cyclical numbers. We just saw a tick higher in January SAAR rates to more robust volumes.

The supplier chain problems for chips have been one major factor holding back production. The detoured investment capital into EVs without a lot of earnings to show for it today is something the market looks past for now. The growth prospects and valuation tailwinds for EV success is likely to outweigh any cyclical worries for now.

GM lights up the screen with 4Q22 earnings…

The stock chart underscores that there is quite a bit of shifting in the stock performance rankings across various trailing time horizons. Under the “what have you done for me lately?” school, GM surprised the market to the upside while Stellantis and Hyundai are navigating the industry headwinds better across the combination of product launches and supply chain headaches (among the short list of major challenges). GM set the doubters back with its guidance and the market reacted accordingly. Very strong earnings, cash flow, and some cash deployment color on assuring lithium supply got the market justifiably excited.

The full year of 2022 saw GM putting up a record $14.5 billion in adjusted EBIT. The results included some bragging rights on market share performance while investment activity offered GM the opportunity for some pep talk marketing around where they are in the EV evolution. Cash flow is being heavily directed toward EVs and AVs, so the company is in turn jawboning investors to get more bullish on multiples.  The worries from the bearish crowd wonder what sort of return the capex will generate as they materially outspend Ford in capex on such programs. “Is it too much in relative terms?” was the question. Time will tell.

GM provided detailed guidance including $10.5 to $12.5 billion in EBIT, cash provided by operations of $16 bn to $20 bn and capex estimates of $11 to $13 billion. The free cash flow frames out in a $5 bn to $7 bn range. When you ponder the size of these numbers and map it across more OEMs who face many of the same investment demands and product segment targets, it gets easier to see how the investment cycle in the broader economy has some tailwinds. These investments are also supported by legislation out of Washington to support a portion of these initiatives.

The GM Financial (“GMF”) part of the picture has the usual concerns the market sees all across the consumer finance universe on what “normalization” means in terms of risk exposure. GMF provides detailed stand-alone slides and strategy outlines, and its own 10K offers plenty of data points as well.

The prime-heavy portfolio offers a good microcosm of a quality lender’s exposures. The real action in auto retail and lease losses will be more in the world of the specialty nonprime and subprime lenders and the expanded lender partners brought in by the independent dealers and used car players. That is a topic to look at as more companies report.

GMF has a weighted average FICO score of 748, and the portfolio is around 73% prime. GMF charge-offs ticked higher in FY 2022 at 0.7% vs 0.6% in 2021 while annualized charge-offs from 4Q22 remain below 1.0% (at 0.9%).  Repossessions are only 0.1% of average retail finance receivables, so that is not a major risk factor here.

Losses on repossessions rise when used car values decline, but the employment backdrop is supposed to take some of the edge off repossession fears and residual value erosion from too many repossessions. That does not change the probability of GMF portfolio metrics getting worse whether you call it normalization or cyclical erosion. The delinquency rate of 31-60 days is 2.1% (vs. 1.8% 4Q21), the 60+ days is 0.7% (vs. 0.6% 4Q21), and repossession adds 0.1% (essentially flat to 4Q21) for a total of 2.9% delinquency vs. 2.5% in 4Q21.

GM’s main event is still going to be about EV execution and its continued ability to make its case.

Ford takes a minor wound in the 4Q22 reporting derby…

While GM was getting its blue ribbon on Friday, Ford was getting taken to the woodshed by the equity markets as it ended -7.6% on the day but off the lows. For the week, Ford’s legacy Detroit 3 peers posted the best results with Stellantis (a legacy peer with an asterisk) with GM materially outperforming the group of Ford, Stellantis, Toyota, Nissan, Honda, and Hyundai. STLA ran a solid second on the week.

 STLA and Hyundai have been the equity winners over three months as well. In some ways, they are all fighting the same battle around chip and supplier chain stress and EV transition. They all face disproportionately large capex demands for revenues that will not come in scale for years relative to the upfront outlays.

Getting into the weeds on Ford’s headline earnings misfire, production problems tied to the supplier chain issues was a problem in the US and Europe while China is still losing money. Adjusted Automotive EBIT for 4Q22 was weak and concentrated in North America with Europe and China in the red and South America minimal. Ford Motor Credit was down in 4Q22 and materially so for FY 2022. The good news is that adjusted free cash flow was strong. During 2021, the auto operations did receive an outsized distribution of $7.5 bn from Ford Motor Credit that declined substantially in 2022 to $2.1 bn.  

The swing in Ford Motor Credit (“FMCC”) earnings was enormous at a $2.5 billion negative YoY decline. The 2022 FMCC earnings was only $349 mn below FY 2020. The expense demands for provisioning (after booking profits on credit losses in 2021) added up. As we discuss below, the 2021 used car market brought some financial positives that were highly unusual for those engaged in leasing, used car sales, or in car rental among others.

FMCC booked a lofty $4.5 billion net income in 2021, but that declined to $1.99 bn in 2022. The Ford FMCC earnings come with some moving parts in the trend line around loss provisioning that needs some additional consideration. Distributions to Ford Motor were down to $2.1 billion from $7.5 billion in 2021 and $3.3 billion in 2020.

FMCC included the following in its 10K: “We expect full year 2023 EBT to be about $1.3 billion, down about $1.1 billion, primarily reflecting unfavorable lease residuals and credit losses and the non-recurrence of derivative gains. We do not expect to pay distributions to our parent in 2023, reflecting anticipated growth in receivables.” We have been down this path before on cash flow upstreaming to the parent companies with the major auto names. The earnings outlook for FMCC is under pressure and it appears it will not be a major source of cash flow to Ford Motor in 2023.

Ford Motor Credit drives home how the accounting line items leave a lot of room for (completely legit) and GAAP-compliant massage therapy. During 2021, FMCC booked $310 million in income for its credit loss provision (as in not expense) vs. $39 million of expense in 2022 and $828 million in expense in 2020. For the years from 2017 through 2019, that expense line averaged just under $400 mn per year.

Booking income instead of expense is defensible in audits and is not a new experience on the credit loss provision expense line. In a market where people are debating “recession” risk, however, a $39 million expense line for credit provisioning is bold. That swing alone was a $349 mn negative variance in the expense line from 2021, but it is one that will be much higher in periods ahead.

Another favorable expense line that exploited the super bullish used car market valuations was the operating lease depreciation rates in 2021. Those declined by over $600 million and bolstered the 2021 bottom line. That same depreciation popped back up in 2022 by $544 million and hit the bottom line as used car economics started to move back into a rational relationship vs. new as 2022 wore on.  The combination of the lease depreciation expense effects and credit losses on receivables was a negative expense variance of $893 million. It adds up as the assumptions and estimates swing around.

The moving parts of the income statement on asset quality do not signal major problems during 2022, but the sequential trend does hammer home that normalization (aka deterioration) of credit quality is underway. The loss to receivables metric is very manageable at 0.11% for the year but ended in 4Q22 at 0.25% or a multiple of those posted in the first two quarters. Reserves as a % of end-of-period Receivables were down to 0.82% from 0.96% in 2021 and 1.18% in 2020. In other words, FMCC will be adding a lot to reserves in periods ahead to get them back up to a bigger cushion.

Ford’s expectations for 2023 include a mild US recession and moderate European recession. They expect a sharp decline in FMCC as detailed above and are clearly anticipating (and hoping) for better supply chain conditions to hold during the year. Adjusted free cash flow will be down to $6 bn from $9 bn. Capex will climb to $8 bn to $9 bn from $6.5 bn. Ford has a lot on its plate as do all the OEMs. Getting back to investment grade in 2023 will be an uphill battle.