General Motors disclosures should remind investors that GM has an interesting SOTP angle. While the 10K dropped language related to timing of Cruise Commercialization (we still expect this w/in the next 12-months), the company is clearly preparing for bigger things. Cruise employees and management are receiving Stock Options and RSUs that vest upon an IPO. On the negative side, GM also continues to disclose potential residual risks related to the bankruptcy of old GM (Plaintiffs want 30 MM additional shares for the GUC trust; GM will fight this at a March 11 hearing); The Takata recall could cost $1.2 bn (though GM is still seeking to avoid a recall).
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GT hosted their Q4 conference call early Friday morning (02/08/19)… The reaction was severe, with the stock declining 9% on the day. This call was particularly aggravating given that GT spoke to investors just 3-weeks ago. 4Q18 earnings quality was lower than expected. The 2019 outlook now looks worse (Mgmt. previously indicated SOI could be flat). We’re lowering our 2019 SOI estimate to $1.2 bn from $1.4 bn (vs. $1.274 bn in 2018). Our new 2019 SOI estimate corresponds with $230-$260 MM of 2019 Free Cash Flow, $380-$400 MM 2019 Free Cash Flow ex restructuring and working capital. We’re lowering our DCF derived TP to $22.
There were numerous interesting takeaways from the Wolfe Research Auto Conference in Detroit, including revealing insights into recent shifts amongst U.S. New Vehicle Buyers (there may be less risk to industry mix than we perceived), the trajectory of battery costs, insights into Powertrain plans being made by Auto OEMs, and revelations on the Ride-Share business model. All of these have long term implications.
The Market is bracing for challenges as we transition to 2019, including lower Auto Production (particularly in China and Europe during 1H19), higher Rates (which raise concerns about Mix, Pricing), the strong U.S. Dollar, Regulatory Content, unpredictable Government Policy/Tariffs, the burden of increased Spending on Technology with uncertain returns, and in some cases discontinued passenger car products.
The current auto sales run rate in China, if sustained, would imply a 10% sales/production decline in 2019. Europe won’t be easy either, as production headwinds spill into 1H19. The U.S. has been relatively strong, but we remain concerned about affordability headwinds. Given these uncertainties, we question why OEM/Supplier margin expectations are up from 2nd half 2018 levels.
Once a quarter, we comb through corporate filings and summarize the most noteworthy datapoints. At a high level, developments during the quarter reinforced our view that investors should be Underweight Autos and Auto Parts, Underweight Dealers, and Overweight a relatively small selection of companies that fall into the Auto 2.0 category. In our view the U.S. Auto Cycle is in its 8th or 9th inning, with looming pressures on vehicle affordability. China is experiencing its first real Auto Industry downturn, and we are not convinced that the Central Government will step in to specifically prop up Autos. Europe also faces a number of challenges: These include potential trade risks (7% of Europe produced vehicles are exported to the U.S.), political risks (Brexit), and regulatory risks (vehicles more expensive to produce, at the same time that pricing has become more challenged).
We’ve been bracing for a tough Q3 earnings season. European Auto production, China Production, and FX headwinds all intensified over the course of the quarter. We’ve been expecting misses/guidance revisions from number of companies in our Universe (Based on the company’s business model and regional profile, Delphi struck us as the most at risk prior to Friday’s pre-announcement). But we’d note that the risks are not equal. BWA already adjusted guidance at their CMD. AXL may even have upside. Our analysis also suggests surprisingly benign results/guidance from LEA, DAN, MGA, and APTV. On the other hand, consensus for GM, F, GT, CTB, ALV, VC, and VNE may require downward adjustments.
We are initiating on HOG at Peer Perform with a year-end price 2019 target price of $46. Our target price uses a 12.0x P/E on our 2020 EPS of $3.86. Our 12.0x P/E multiple is in-line with where shares are trading today, but a significant discount to history which we believe is appropriate given our secular and macro concerns.
The company faced dramatic increases in raw material costs and passing these along proved much more challenging than expected. And volatility continues into 2H18E—China demand weakness and FX (Turkish Lira / Brazilian Real) could represent an additional ~$80 MM headwind vs. expectations set at Q2. We expect Segment Operating Income (SOI) to decline to $1.37 bn in 2018 (guidance was $1.45-$1.50 bn), down from $2.0 bn in 2016.
Our analysis of vehicle affordability and price elasticity suggest that the U.S. market could face a 1- million-unit decline, even without a recession. Partly due to changes in China government policy, this market may no longer be as consistent a source of growth and profitability. Europe faces significant regulatory challenges.
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