By Daniel Muraga - www.leverageequityresearch.com
Big M&A rumors recently broke that Toyota Motor Corporation (NYSE:TM) is considering a possible purchase of General Motors (NYSE:GM), currently the largest U.S. automobile manufacturer. Iconic Japanese brand Toyota Motors, with its $153B+ in market cap, is 3.8x bigger the U.S. auto maker GM. It is reported that Toyota may be interested in making a bid for GM around $45, significantly higher than its current ~$29 share price. While consolidation of the automotive industry has been likely for some time, this is the first rumor of its kind regarding the two manufacturing giants.
Regardless of a potential merger, several analysts painted a positive picture of the US automotive sales environment in 2016. Despite a difficult May that saw a 6% decline y/y, domestic car sales are still projected to break the all-time record of 17.5 million set last year. GM held a 17.3% market share in the U.S. at the end of FY2015.
Planned Reduction/Leaner Strategy
Although GM's sales were down by 18% in May, this is primarily due to a move that was aimed at benefiting the shareholders in the long term. The decrease is not a drop in sales, but rather a planned reduction, with GM shifting away from rental car fleet sales in favor of a greater focus in retail sales. The rental car sales segment is currently not as profitable as the retail car market.
This is a move done by both GM and Ford (NYSE:F) as both companies aim to increase profit margins, and the strategy appears to be working as the EPS for GM rose 47% in the first quarter despite reduced trading volumes.
GM data by YCharts
A major reason for the decision to shift away from the rental car market was that the residual values of GM's vehicles have increased dramatically in recent years. This is due to the improvement in the company's cars as well as the limiting of rental car fleet sales, as the influx of rental cars in the marketplace hurt residual value for leases. GM has steadily raised its notoriously low residuals in the past few years to the industry average of ~47% after three years. As the residuals for GM autos go up, the cost of a lease becomes less expensive and thus more attractive to the consumer.
GM started 2016 with a leaner inventory compared to the year prior. In January 2015, the company reported U.S. inventory of 737,444 vehicles, equivalent to 70 days of supply. However, as of June 2016, the company had U.S. inventory of 630,950 vehicles, equal to 60 days supply. Because lower inventory leads to reduced discounting, a shorter inventory supply rate is a good sign moving forward.
GM's flagship Chevy Silverado and GMC Sierra full-size pickup models continue to attract users due to the current low fuel prices. GM currently has 22.4% of the truck market in the U.S. as of Q1. 824,683 full-size pickups were sold in the U.S. in 2015 - up 11% year over year. In May 2016 alone, over 90,000 pickups were sold, a figure that has not been recorded since 2007.
The company has also been performing well in China, a particularly strong car market currently, with a 4% gain in sales in Q1 year over year.
General Motors has heightened its restructuring efforts in its foreign markets by closing plants that are deemed inefficient and merging production in bigger plants. GM is also reducing the number of automobiles it is developing in order to check development expenses globally and benefit with economies of scale. These moves are aimed at reducing losses in markets outside China and U.S. for 2016 and beyond.
However the potential Toyota-GM merger talks may go, GM is positioning itself for strong earnings growth within a currently favorable domestic car market. Expect this to just be the beginning of potential merger talks regarding GM.
Disclosure: I/we have no positions in any stocks mentioned, but may initiate a long position in GM over the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.