TSLA - Ford Vs. General Motors: EV Marathon

2023-04-20 10:20:45 ET

Summary

• General Motors Company and Ford Motor Company remain committed to producing many EVs, but supply constraints and high battery costs may force them to delay production timelines.
• Ford aims to produce 600,000 EVs annually by the end of 2023, while GM aims for 400,000 in North America within two years, but both targets may face delays.
• Ford is repositioning in North America to improve profitability, while GM is working to increase battery production and reduce fixed costs.
• Ford has also re-segmented its business to accelerate its transition to an EV world.

Investment Thesis

Ford Motor Company ( F ) and General Motors Company ( GM ) are taking significant steps to increase the production of Electric Vehicles (EVs) and secure the materials needed to support this growth. As a result, long-term investors in the automotive industry should be optimistic about the EV ambitions of these companies, which could drive long-term value creation. However, investors should also remain cautious about the risks of delays and the costs associated with EV production.

The auto industry has experienced a storm of headwinds over the past four to five years that has increased ownership costs, decreased affordability, and restricted the supply of vehicles due to chip shortages. However, there are signs that the majority of the headwinds subside, supported by the realization of pent-up demand, supply chain improvements, and cost absorption increases at the customer level.

Even though the sector allocation remains neutral, I consider this a good entry point at a reasonable valuation before a sector rerating, leading to the buy rating for both stocks.

Re-Segmentation Could Reap Benefits For Ford

Last year, Ford announced its plan to re-segment its business, shifting from regional to Internal Combustion Engine ((ICE)) to EV segmentation. A recent teach-in clarified the new operating structure and the go-forward strategy. While some may believe high EV pureplay valuations influenced the reorganization, the teach-in reinforced that it was a move to effect change and accelerate Ford's transition to an EV world .

According to Ford, the current organization is unsuitable for the EV transition due to its complexity and legacy processes. The reorganization separates the ICE and EV businesses, allowing for greater opportunities to develop EV products without ICE constraints, faster development, and different processes. Moreover, this move also enhances accountability. The ICE business will focus more on margins and cash flow, benefiting from the long tail of products like trucks.

One of the critical debate points of the teach-in was around commentary that Ford would achieve a breakeven contribution margin on Model E's first-gen EVs later this year. Ford noted that the primary driver of improvement would be reduced material cost, as Ford is continually finding opportunities to make material usage more efficient.

Ford is focused on simplifying and reducing complexity, which is visible in that their initial EVs were based on their traditional ICE platforms and not built with optimization in mind. However, implementing significant changes to the content of a vehicle's platform mid-life can be challenging and may take time to deliver results. In addition, the pressure to price EVs competitively in the short term may also impact their profitability.

Profitability Remains A Challenge

Legacy automakers are facing a challenge as EVs break even at approximately $60,000 , unfavorable for profitability. Due to this, they are hesitant to give up their high-margin trucks and SUVs. Moreover, an emerging shortage of critical battery minerals leads to a rise in prices despite a first-quarter reversal, causing manufacturers to pause and rethink aggressive timelines for EV production.

The margin disadvantage, when compared to legacy technology-powered vehicles, which generate lucrative returns, could lead to scaling back of long-term ambitions. This could compromise Ford's and GM's plans to have an annual installed EV capacity of 2 million units each by 2026. In addition, although the Inflation Reduction Act has extended clean-vehicle credits, it is unlikely to significantly increase EV sales due to income, vehicle price limitations, and eligibility uncertainty.

Ford & GM Stand Firm On EV Ambitions

Ford is steadfast in reaching an annual production run rate of 600,000 EVs by 2023. However, compromised consumer demand and high battery costs put profitability at risk and may motivate the automaker to push that timeline back. For example, the company is allocating 270,000 units to the Mustang Mach-E and 150,000 to the F-150 Lightning, yet achieved February U.S. delivery run rates of 21,600 and 17,000, respectively.

General Motors has added six months to the two-year timeline to produce 400,000 EVs in North America, which still is an ambitious target subject to supply constraints and demand uncertainty that leaves the door open for more delays. Nevertheless, the automaker now expects to surpass the goal in 1H24. However, the electric-vehicle roadmaps for Ford and General Motors may fall short of ambitious timelines in the short run, compromised by a deteriorating economic outlook and elevated battery costs.

A Rally Around U.S. Profit Center

Competitive disadvantages in Europe, China, and South America are driving Ford to refocus on its more profitable platforms and North America even as it results in fewer units sold. Cost rationalization will enable the automaker to scale back production in North America while enriching revenue and adjusted Ebit with a ~95% pickup and SUV mix in the U.S. The next shift in the lineup will be higher-priced EVs infiltrating segments dominated by internal combustion versions.

Ford's refocus on North America will limit exposure to low revenue and profit-contributing regions, increasing the company's adjusted EBIT per unit. The shutdown of Ford's mobility unit, which lost $926 million in 2022, is the latest instance of the company circling the wagons around the core North American automotive business that contributed 95% of the company's total adjusted Ebit in 2022. Pickups and SUVs were 98% of Ford's U.S. retail revenue in 2022, providing little room to further shift to a richer mix. However, its electric vehicle transaction prices were 24% above the company average.

GM's Battery Production & Materials Supply Are Improving

General Motors is working to ramp up EV production to meet its mid-term targets. To support this, GM is ramping up its Ultium Cells joint venture plant in Ohio and plans to open a second facility in Spring Hill, Tennessee, later this year. The Ohio plant is expected to add approximately 20% capacity each quarter and reach its total run rate by the end of the year, producing around 35 GWh. Meanwhile, the Spring Hill plant is expected to ramp up faster than the Ohio plant due to the lessons learned from the initial process, producing around 35-50 GWh. In addition, GM is expected to benefit from at least $300 million in total IRA incentives for the year as these plants scale, mainly from the battery production credit.

In addition, GM has made a $650 million equity investment into Lithium Americas Corp. ( LAC ) to jointly develop the Thacker Pass mine in Nevada, the largest known U.S. source of lithium and the third largest globally. The lithium extracted and processed from the project will be used in Ultium cells and will be enough to support the production of up to 1 million EVs annually. Production at the mine is expected to begin in the second half of 2026, providing considerable scale once ramped up to total capacity. GM is taking significant steps to increase EV production and secure the materials needed to support this growth.

GM Focuses On Reducing Costs

GM has announced plans to offer a voluntary separation program ((VSP)) to salaried employees to reduce its fixed costs. The VSP will be available to any salaried worker with at least five years at the company or executive with 2+ years of service. Eligible employees will have two weeks to sign up and receive a lump sum payment and other forms of compensation to exit. GM expects most of its 58k U.S. salaried workforce to be eligible for the buyout.

The company aims to reduce fixed costs by $2 billion on an annualized run rate basis by the end of 2024, with 30-50% of that coming this year. In addition, GM expects to incur up to $1.5 billion in employee separation charges, mostly cash-based, and up to $300 million in pre-tax non-cash pension curtailment charges. The final charges will be based on the composition of employees that volunteer for the program.

Valuation Remains Reasonable

Following the news of further Tesla, Inc. ( TSLA ) price reductions for sure of its Model Y and Model 3 EVs, the whole sector has faced a pullback, creating an attractive entry point for F and GM. This is the sixth time this year that Tesla has reduced U.S. prices due to worries about how it will affect its profit margins for automotive.

Thus both stocks trade at a discount, with GM's P/E ratio hovering at 5.6x, below its one-year average of 6.4x. Indeed, the overall prognosis of the car sector is hampered by increased vehicle costs brought on by regulatory changes, decreased rural participation due to rising prices, and sluggish exports. Nevertheless, I remain confident that once the headwinds subside, both stocks can get a rerating in the following 6-12 months amidst the cyclical uptrend.

Takeaway

Ford Motor Company is refocusing on North America to improve profitability, while General Motors Company is working to increase battery production and reduce fixed costs. While the aggressive timelines of GM and Ford's EV production plans may face delays due to supply constraints and battery costs, both automakers are committed to their EV ambitions. As a result, the storm of headwinds is coming to an end, and a rerating in both Ford Motor Company and General Motors Company stock valuations in the following 6-12 months is highly probable.

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