Favorable macro trends and company-specific improvement have helped General Motors (GM) remain a strong performing holding in our Top 20 Dividend Stocks portfolio.
Earlier this morning, the company announced some good news for shareholders. GM raised its 2016 earnings outlook by 5%, boosted its dividend by 6%, and increased its share repurchase plan by 80%. Shares advanced by 2-3% in early morning trading.
From a macro perspective, the auto industry is benefiting from record U.S. volumes, low borrowing costs, and strong consumer spending and employment. Low gas prices are also driving strong demand for GM’s trucks (38% of sales) and crossovers (25%).
GM expects slow to modest growth in 2016, not unlike what the company experienced in 2015. The company also noted “significant progress” on its strategic plan and said it reached its 10% operating margin goal in North America in 2015, one year ahead of schedule. Company-wide, GM said continued execution of its plan should keep GM on track to achieve 9-10% EBIT-adjusted margin by early next decade.
Despite all of the good news, GM trades at a forward P/E ratio of just 5.6 and has a forward-looking dividend yield of 4.9%. Investors clearly remain cautious on the company for several reasons, with fears of the auto cycle approaching a cyclical peak a leading concern.
Many analysts have been calling for the U.S. auto market to peak for the last several years. Market researcher HIS Automotive predicts the market will experience a pull back after 2017 due to higher consumer borrowing costs (as a result of rising interest rates), historical demand patterns, and a glut of vehicles coming off leases (which could reduce demand for new car sales).
Others fear that auto companies have lowered their lending standards by too much in an effort to boost near-term sales. According to data from the Federal Reserve Bank of New York, over the six months through September 2015, more than $110 billion of auto loans were originated to borrowers with credit scores below 660, the bottom cutoff for “good” credit scores. Roughly $70 billion of that amount went to borrowers with “bad” credit scores below 620.
Despite the caution expressed by IHS, the organization still expects U.S. auto sales to peak at 18.2 million vehicles in 2017 before gradually drifting to around 17 million by 2022 – hardly the plummet we experienced during the financial crisis.
Still, no one knows what trajectory vehicle sales will take, but they notably reached an all-time high during 2015:
Downturns are inevitable following periods of substantial sales growth. Many investors remained scarred by the hit carmakers took during the financial crisis – GM and Chrysler were bailed out by the government and required bankruptcy restructurings to survive.
However, these businesses are in much better financial shape than they have ever been. We outlined many of the material changes made to their cost structures and balance sheets in our initial thesis on GM, and it’s worth noting that Warren Buffett moderately increased his stake in the company over the last year as well.
Your guess is as good as ours regarding where the auto cycle goes from here, but we still believe GM’s improved earnings power is significantly underappreciated by investors. The company’s improved profitability, balance sheet, and conservatism should also help it continue paying its dividend in almost any environment (GM’s forward-looking payout ratio is only 28%).
With the average age of cars on U.S. roads at a record 11.5 years, the current auto sales cycle could also sustain itself much longer than expected. Time will tell.
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