To The Moon

For Tesla, GM, and Ford Investors, Uncertainty Is the New Certainty

Automotive investors seem to have given up on 2023 already. The new year might not turn out to be as badly as they fear, however.

Sure, there are many unusual cross currents and concerning data points for investors to digest. But there are some positive factors to consider, too.

What's certain is that 2023 isn't an easy year to forecast. Typically, auto sales fall when the economy weakens, but over the last couple of years, sales have dropped while the economy boomed. Global production has been constrained by supply-chain disruptions thanks to Covid, a shortage of semiconductors, and even the war in Ukraine.

Heading into 2023, "uncertainty is the new certainty," says David Greene, principal industry analyst at $Cars.com(CARS.US)$. He's paying close attention to vehicle affordability, electric-vehicle demand, deflation, and inventories, along with the state of the economy and overall automotive production.

Affordability

$CarMax(KMX.US)$ shocked investors when it reported weaker-than-expected earnings on Dec. 22. Unit sales at retail dropped more than 20% year over year. CarMax cited declining vehicle affordability as a problem.

Monthly car payments are getting more dear. The average interest rate now for a new 48-month auto loan is 5.5%, up from about 4.6% at the start of the year, and the highest level since summer 2011.

Higher rates raise car payments. So do higher car prices. The average price for a new car -- electric vehicles and conventional -- in the U.S. was $48,681 in November, according to Cox Automotive. That's a record.

Deflation

The solution for affordability will be deflation. $Tesla Motors(TSLA)$  CEO Elon Musk told investors Thursday that deflation has arrived.

That will lower costs, and eventually lead to lower car prices. Deflation can be a double-edged sword for the industry, though. Lower costs are great, but falling car prices can result in lower demand as car buyers wait to buy.

Production

The other thing that will lead to lower car prices is better supply/demand balance. Demand for new cars has outstripped supply since the pandemic -- thanks mainly to constrained production.

U.S. light-vehicle sales are expected to be about 13.8 million units in 2022, down from 14.9 million units in 2021. Sales averaged about 17 million units a year in the three years leading up to 2020.

Sales are expected to rise to about 14.8 million units in 2023. Up is good for bullish auto investors, but anything less than 15 million units is a recession-like number for the U.S. auto industry, comparable with the volumes of the sluggish economy of the late 1980s and early 1990s, adjusted for population growth.

EV Demand

It's a safe bet that demand will be in the range of 14.8 million units, even if the economy does weaken. It's also a safe bet that car makers won't make more than that even if they could. Production problems won't evaporate all at once.

What is also apparent is that more EVs will be sold in 2023. Wall Street, however, has begun to worry if the auto industry can sell all the EVs they can make in the coming year.

Morgan Stanley analyst Adam Jonas recently cut his estimate for EV penetration of new-car sales in 2025 to 11% from 13%. EV penetration of new-car sales in the U.S. hit 6% in the third quarter of 2022.

Through the end of September, about 576,000 battery EVs have been sold in the U.S. in 2022. That's up about 70% compared with the same span of 2021.

Canaccord analyst George Gianarikas sees EV demand in 2023 accelerating worldwide, boosted by the new U.S. tax credits passed as part of the Inflation Reduction Act, and sales growth in China.

Citi analyst Jeff Chung estimates EV demand in China will hit about 8.5 million units in 2023, up about 33% from 2022. That includes both plug-in hybrids and battery EVs. About 75% of electrified sales in China are battery EVs.

Chung's number puts battery-EV penetration of new-car sales in China at roughly 30% for 2023, up from about 24% in 2022. EV penetration of new-car sales in Europe is at about 12%. It's been increasing, but more slowly than China and in the U.S.

Taken together, battery-EV penetration of new-car sales in major auto markets in 2023 looks to be roughly 18% to 19%, up from 14% to 15% in 2022. S&P Global calls the electrification trend unstoppable. That sentiment differs from Wall Street worries these days.

Stocks

What those EV numbers mean is that Tesla will have to maintain its 20% global market share of EV sales to hit 2023 sales estimates of about 1.9 million units.

Investors seem to be expecting bad news. Tesla stock is down about 65% year to date and shares are at levels unseen since mid-2020.

Investors aren't enamored with any car stocks really. $General Motors(GM)$ and $Ford(F)$ shares are down about 43% and 45%, respectively. Concerns for those three aren't as much about market share and volume growth as they are about profitability.

Investors should expect profit margins to come down in 2023. That's what Wall Street expects. Analyst project operating profit margins at GM, Ford, $Stellantis NV(STLA)$ and $Toyota Motor Corp.(TOYOF)$  to fall to about 8% from 9% on average.

Tesla profit margins are expected to expand by about 1 percentage point in 2023. That might be optimistic, considering expectations for the rest of the industry.

Valuations

Flat or declining margins might not hit Tesla stock all that much in 2023, though. Shares now trade for about 22 times estimated 2023 earnings, the lowest price/earnings ratio ever.

GM and Ford stocks trade at roughly six times estimated 2023 earnings, versus an average of closer to eight times over the past couple of years. Parts giant $Magna International(MGA.US)$ trades for roughly nine times, versus an average of about 11 times over the past couple of years.

What to Buy

Below-average multiples may mean that investors expect earnings estimates to get cut. Stocks don't typically rise when estimates are cut, but with valuations so low, some level of disappointment is already baked into auto shares.

What to buy, of course, depends on an investor's outlook and style. Rising sales should help out parts companies, such as Magna. It means more parts to deliver to OEMs.

Whatever happens in 2023 investors should remember the saying "strong views held lightly." Lots will happen, and change, for the auto business in 2023.

@TigerStars  @Daily_Discussion