Episode Transcript
[00:00:00] Speaker A: The markets, we just can't get enough of them.
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Welcome to episode 186 of Magic Markets. And this week we have set out to answer what I think is quite an interesting question, Mo, which is whether or not automotive sector stocks are a good investment. So, you know, should you be out there looking at the big names that you would typically want to put in your garage? Would you want to put them in your portfolio as well? So I'll tell you what I'll do is kick off quickly with some of the share price performances of the two companies that I've gone off and researched, and then I'll hand over to you to talk us through the companies that you've looked at. So Mo, the first one I looked at is Toyota. And what's interesting is we've covered Toyota previously in magic markets premium. We did it a few months ago. I'm pleased to say that we directionally were right about the problem there, but I'll cover that in detail later. What I want to do is rather lift my head and say, okay, over five years, what does the performance look like? Because that kind of answers the question directly of are these good investments? So over five years, Toyota's ADR listing in the US, that is up 49% over five years in total. Now that is actually not great. So here's why that's not great. The S and P 500 index has done 86% over the same time period. Now, both of these things are excluding dividends, and Toyota's dividend yield, I think is a bit better than the S and P 500. But either way, not enough to make up that gap. Now, the S and P 500, of course, is full of technology stocks. So we got to be careful here. I went and had a look at the industrials sector within the S and P 500, and that is up 67% over five years. So even Toyota, as one of the stalwarts of the industry and one of the better performing companies, I think, as we'll get to, has underperformed the industrial sector on the S and P 500. So, you know, the quick answer to the question is it doesn't seem as though the automotive sector is a great place to put your money. Toyota certainly hasn't suggested that it is. And the other one that I've looked at is BMW, which we haven't covered before in detail on magic markets premium. And maybe we should at some point. The ADR in the US trades under the stock ticker. BMW YY trades over the counter, and it's up 31% in the past five years. So way below Toyota, way below the indices that I've already referenced. Not a great start for the automotive sector on the show, is it? Mo indeed, Ghost.
[00:03:05] Speaker B: And I mean, automotive is a very important sector for South Africans. I know a lot of our audience are south african listeners, and South Africa has a very large automotive export sector. So what we discuss on the show is also important in terms of informing your outlook on just that segment of the south african economy. You've looked at BMW, you've looked at Toyota. I'm going to look at Ford and GM. I'm in North America. I thought, let me take the two north american giants if you want to look at that. And interestingly enough, I'm going to do the same thing you did, Ghost, is if we look at it over five years and you look at Ford, just. And I'm going to cheat a little bit here. Right. Just before the last set of results, Ford actually delivered a comparable performance to Toyota over the five year time horizon, up around 49%. Now, that is definitely a cheat because the last set of results, and I'll get into the detail of why they disappointed, the markets actually saw the stock trade down sharply in the double digits, and so it's now sitting around 14% over five years. How's that for a bad investment case over five years? Yes, you heard that correctly. If we have a look at GM, how have they fared? Well, similarly poor and, in fact, underperforming forward over a five year time horizon at around 11%. So I think wrapping up the automotive manufacturers good investments over the long term. If you look at a long term, kegar, and I want to frame this by looking at the highest performer in the subset, Toyota, versus the lowest performers, GM. If you look at a compound annual growth rate over five years, that translates into, at the low end, 3.5%. That's horrendous. You could probably get a better result by investing in government bonds, certainly in the US. If you have a look at Toyota, 8.4%. Kegar. Still not fantastic. Not enough to write home about. Ghost, I'm going to use that now jump into just the relative performance. And looking at Ford and GM, I mean, you had mentioned the dividend yield on Toyota and how that looks slightly better than the S and P 500. But when you look at the dividend yield in general in the industry, Toyota is kind of in the middle of the pack. It comes through around 2.5%. Now, the reason I wanted to cover the north american stocks is Ford has this very high dividend yield. And it's like the siren song it's calling out to me. It's saying, mo, look at me. You know, at 5.5%, that is a fairly juicy dividend. And it's certainly at the higher end of the spectrum when you look at this industry and then GM, by contrast, a 1.3% dividend yield. So showing you very different capital allocation priorities across the various companies. And what stood out for me, Ghost, looking into the underlying performance is first and foremost, if we have a look at Ford's earnings per share, it came through at share. And the reason the market reacted so sharply to the downside negative reaction is that the market expectation was for an earnings per share number of $0.68. That is a massive miss. Massive. I mean, you can't really put it any other way. And that is the reason why Ford underperformed so sharply, is that despite the fact that it had a decent dividend yield, even going into the announcements, despite the fact that they seem to be doing a lot of positive things in terms of rationalizing their production line, right, sizing the EV investment, the market's expectations around that. And that's why it's so important to look at those expectations were quite bullish and Ford disappointing on that earnings per share number. Now, another point I want to highlight, Ghost, is on the strategic basis, if you look at Ford and you contrast that to GM, we know that Ford was one of the companies in North America that was quick out of the blocks in terms of its EV investment. They had this mach E, which is effectively a Mustang, an electronic Mustang. It looks really attractive, but it really disappointed the market in terms of just its performance. You know, when you're looking at EV's, you're looking at range, you're looking at a number of other indicators. And Ford coming through with what looked to be an attractive product that really then started to disappoint in terms of its performance. And you've seen that over the course of the last several earnings releases, Ford has been dialing back on the, let's call it the narrative around its EV segment. And in the latest results, that EV segment actually faced significant losses, $2.5 billion to be precise, in the first half of 2024. And that comes as forward a over invested. They're now dialing back on that production capacity. They're also starting to talk the same book that Toyota has been talking. They're saying, look, we're looking at hybrids. There's been a substantial increase in hybrid sales. And, I mean, seeing that come through is really a maturation of some of the mega trends we saw where the market really got quite excited around the EV narrative. And what's interesting is you saw that EV narrative reflected in all of the us stocks, obviously Tesla, the poster child for EV's. But you saw that narrative really impact Ford. You saw it impact GM. And they both pushed to these massive highs between 2021 and 2022 that framed the top side. And if you were an investor at that hyped level, you have lost a lot of money. Now, the last point I want to land on here is just the difference in strategy between Ford and GM, because it ties into this discussion around EV's and hybrids. We've spoken about how Ford is kind of dialing back on the EV's, looking at the hybrids as a solution in terms of how the industry is maturing. But if you look at GM, they're at a very different part of their development cycle. GM effectively doubling down on its EV investment. Effectively. They did not invest as heavily as Ford did. And if you looked at their recent results, it was actually decent. You know, the EV sales showed strong growth. They sold around 22,000 units in the second quarter of 2024 and they continued to invest heavily in their EV lineup. So the question mark for me on GM is, are they just at a different point of the cycle? Are they going to go through the same pain that Ford's gone through with his massive investment in EV and then needing to actually dial that back a little bit later on?
[00:08:54] Speaker A: So most something I've also seen with Ford in the headlines, it seems like they've had some company specific problems as well around the warranty costs have definitely been a big focus as well. So it's the EV side, it's all this stuff. But it also seems as though some good old american build quality demons are catching up with them. Look, I actually don't know exactly what the recalls are, you know, which models it's dealing with, where they were bolts. I'm just teasing based on old Top Gear banter about people building cars by hitting them with hammers. But the reality is that Ford does have a warranty problem and it relates to models, I think before 2021, if I read it correctly when I saw it, not ideal. This is the problem in the sector and maybe this talks to again. Is this an appealing place to invest? Well, warranties are just one of the areas where it can really go wrong for you as a car manufacturer.
[00:09:39] Speaker B: Indeed, I'm glad you bring up the point, kos, because there's stuff that happens below the line. There's the manufacturing, getting the cars out and actually selling that. The things like long run cost of ownership. The warranty problem certainly has been a drain on Ford's finances. And what's also interesting is strategically, Ford's really trying to get that after sales experience right. You know, they're in the earnings call. They go and highlight how many software updates they've done for the EV range as well. So Ford's emphasis has been on getting that after sales experience right. They're talking around, you know, really focusing on the software side of their business as well as a growth engine. And again, that's a slightly different tack to what you're seeing in the rest of the industry. And then going back to the industry itself. If you look at EV's, we've spoken about the residual value of EV's, how they trail off so quickly, how that's a risk or a headwind to the industry. And if you look at Ford credit, which is effectively their financing arm, you know, they actually went, they were at pains to actually stress that they have limited exposure to that EV residual value. So that's telling you that it's definitely an industry factor that you need to have on your radar. A last point on the industry side of things is, like I say, you've got this very differential strategy between Ford and GM. Ford going with kind of after sales, the software updates, GM taking a slightly different tack. GM saying that they're not focusing as exclusively on some of that stuff. They're focusing on the automated driving effectively. We've seen full self drive with Tesla and this was an interesting thing for me with regards to GM because it's a slightly different path to what other industry players have gone down. Looking at overall margins, though, with Ford and GM, they're not fantastic. This industry is a really tough place. And Ford coming through with around a 9.5% gross margin versus GM's 13%. Again, that explaining at the top line why GM has been slightly more resilient. But when you drill that all the way down to operating margins and net margins, net margins for Ford down at just below 4%, for GM at around 6%, those are not great.
[00:11:38] Speaker A: Industry economics goes, no, they definitely aren't. And I think let's move internationally now having covered two of the us based names. So when we covered Toyota back in March in premium, we called it priced for perfection. It was trading at $280 a share under the ticker TM. It's now all the way down at dollar 190 a share. So at the time our view was pretty contrarian. The market could see no run with the Toyota story. So I'm quite proud of this one, to be honest. We don't always get it right, but that one we definitely got right. And the thesis was that despite the focus on hybrid technology at Toyota and the strength of the brand, there was actually a lot to be concerned about. And that's the problem when something is priced for perfection as a share price. Our main worry was actually the japanese market because at the time they had that crisis at Daihatsu that was still pretty fresh. Share price had kind of just ignored that. And in general, Toyota had been riding this wave of strong international sales for years. Now. We highlighted that unit sales in Japan were only up 5.6% over a decade of sales units over the rest of the world were up 17.3% over the same period. That's not per year, that's in total. So very little growth in Japan, not much growth internationally. But the challenge is the japanese market has been operating at a significantly higher operating margin than the rest of the world's markets. So growth was actually coming through over time in the wrong place in their lower margin business. We were also worried about the depreciation of the yen because the japanese profits are worth less to, to international investors over time. And that's a challenge. Now, since we covered the company, it seems like everything just got worse around all the things we covered. On a rolling twelve months basis to March, sales in Japan actually fell 3.7%. When it's taken you a decade to grow 5.6% and you can fall 3.7% in twelve months, that's not good. Now they managed to still achieve a really good result in operating income thanks to just improvements seen across the business and everything else. But the market was pricing in perfection and they didn't get perfection. And so investors who bought at the top got severely hurt. And if you look over the next twelve months, vehicle sales growth, just 0.6% at group level, that's their expectation. Sales in Japan due to fall 6.2%. Despite all of this, the price earnings multiple is only down at 8.1 x, having peaked at over eleven and a half times in March. It's way too high for a car company. It really is. So Toyota, people who bought in at the top this year have had a really bad time. And as mentioned earlier, over five years, it hasn't even managed to hold on to the industrial sector on the s and P 500. And if you're going to pick a stock, you always want to beat the broader sector by a significant margin to make up for the stock risk. In this case, even Toyota hasn't managed that Mo but I can tell you that with what I'm about to share with you in BMW, Toyota actually seems like a dream.
[00:14:24] Speaker B: Yeah, indeed. Ghost and I mean, this is really, I think, why it's so important to a look at the industry from a macro perspective, but then also look at the underlying performances, because you're going to discuss BMW shortly. But what we haven't covered is that there's this rise of the chinese automotive manufacturer and there's so many companies coming through there. So, for example, BYD is making significant inroads. If you look at China as a force on the EV world, just specifically the EV world, very disparate approaches there. You've got, for example, Tesla, that's made good inroads. You've got Ford, that's actually done okay. They've got some manufacturing partnerships in China, and then you've got GM, for example, that's really struggling in China. And this is outside of the competitive forces that those chinese manufacturers are bringing into the market. What is the impact, then on the old incumbents, the VWs, the BMW? Because if you look at BMW and you're going to get into some of this, if you look at BMW, it certainly didn't enjoy the EV hype that the us automotive manufacturers enjoyed. The stock didn't peak at the same kind of time, but they've kind of been slow to the market. I've seen some very attractive models on the road, the I four, for example, a really, truly beautiful ev vehicle. But the question mark there is, is it enough to actually generate substantial, or let's call it at least sustainable economic profit? And I think that's what you're going to answer right now.
[00:15:39] Speaker A: Ghost yeah, so BMW is not a stock we've covered before. In detail, as I mentioned earlier. But it's on a price earnings multiple of 5.25 x, which made me smile because it sounds like a BMW. Right. BMW 525. Very easy to remember the ADR that trades as BMW YY, as I mentioned earlier, and it has underperformed Toyota and those indices. Now, what's interesting with BMW is as you actually open up their reporting, you are met with segments based on automotive versus motorcycles. I was not expecting that. And the margins are much better in motorcycles. 12.2% EBIT margin in the latest quarter, versus only 8.8 in automotive. Wonderful. But over the last year, margins are down severely. And this is the key takeout for BMW automotive, down from 12.1% to 8.8. That is a massive EBIT margin contraction. Motorcycles down 16.5% to 12.2%. It's like all those profits got lost in the grills of one of those new seven series. To be honest, you can lose a whole continent in there, so I'm not surprised. Now, this is part of a broader theme of just concerning numbers. At BMW, profit before tax was down 18.9%. Free cash flow down 35.2%. Now, the reason that I was quite surprised by the segmental reporting of automotive versus motorcycles is because I assumed that the motorcycles are quite a small part of EBIT. And indeed they are. They only contribute 2.6% of group EBIT. So, you know, why is that a separate segment? I'm honestly not sure. And that is because what would you expect to see as the other segment? Financial services, which is seven times larger than motorcycles in terms of profit contribution. Now, the theory here, I guess, is that unit sales drive financial services. So they like to show you automotive and motorcycle and then financial services. The good news is they do disclose all of this stuff if you look hard enough. So, you know, the disclosure is pretty good overall. Here's a fun segmental split. Speaking of that, BMW versus mini versus Rolls Royce, there are a lot of people who go and buy the Rolls Royce share in the UK. I think it is because they think they're getting the car. You are not getting the car. You are getting the aerospace business. Rolls Royce. The car is n BMW. And in the quarter they delivered 1525 Rolls Royce models. Now, for reference, Ferrari sold three and a half thousand units in their latest quarters. So Rolls Royce, roughly one and a half thousand. Ferrari, three and a half thousand shows you how exclusive Rolls Royce still is. But those Rolls Royce volumes were down 7% year on year. Talking directly to the downturn in luxury and I would wager the chinese market is the problem here. And that's probably gotten worse. In the latest quarter, BMW units, those were up 2.5%. Thankfully, 531,000 cars. Mini down 9.4% to 62,000 cars. Also pretty interesting. Here's another stat that's quite fun. Cash versus financed sales. So they delivered a total of 594,500 vehicles in the quarter. New financial services contracts with customers, 422,000. So 422K out of 594. That gives you a good idea of cash versus credit sales of bmws. So, you know, getting away from all the fun little cute facts, which are interesting, but don't answer the question of is the automotive sector a good investment? The point here at BMW, they are struggling for top line growth, but most of all they are struggling for margins. Selling cars is super competitive. Prices really are under pressure and I think for premium cars, especially because of, again, the big competitive threat you've already raised MO, which is chinese cars. A few years ago I would have laughed at you if you'd said to me, oh, chinese cars are going to disrupt the Germans, for example. The reality is that the consumer need is to get from a to b. I know I sound like every old parent's advice now you just need to get from a to b. But it's true. It's a mobility solution. Anything beyond that is a nice to have. When interest rates are high, when things are tough, when you can get a decent chinese car for half the price of a BMW, there's a problem. And all of these things contribute to YMO. For me, this is an unattractive industry to invest a decent chunk of your money in. You can do some stock picking. You can also get burnt. You know, I at one point was looking very good in Ford. Not so much anymore, obviously, so just be careful. But if you're going to look for a long term place to stash your money, for me, the sector is not the place to do it.
[00:19:54] Speaker B: Yeah, ghost, I think that's fair because this is really a stock picker sector. It's a trader sector. You know, if you buy Ford, you know, if you had bought forward in the single digits and you exited Ford in the mid teens, you would have done really well. But you can have to be on top of that stock and you're a trader, you're not an investor. Over the longer term, the economic profits, the margins, all of the highlights that we've actually shared in the show show you that it is a very tough sector. I mean, on your last segment, that financing segment of BMW just blew my mind, you know, 400,000. That. That's massive. And the fact of the matter is that the Chinese are coming in with cheap EV's that you don't necessarily have to finance. So that is a big risk to the incumbents in the industry. Yes. You're going to see the tariff response from the US and they're saying, you know, 100% tariffs on chinese EV's. Well, the Chinese are trying to get around that, you know, they own Volvo. They're going to use Volvo as a brand to try and get their EV's into the us market because it's seen as european and not chinese. And then the US are going to realize they're doing that and they're going to try and levy additional protective measures. In aggregate, though, the industry is a really tough space. We might like some of the brands. It might resonate. I love BMws. Hey, I love Ferraris as well. Does that mean either of these are great businesses? We've covered Ferrari. You can go and have a look at that report. In magic markets premium, we've covered lots of motor manufacturers, Tesla, Stellantis, we've covered Ford as well. I think that wraps up a discussion on. It's a tough industry. If you're going to be playing here, you've got to be a stock picker or a trader, or just get your timing absolutely right and no one picks tops and bottoms efficiently enough to do that.
[00:21:23] Speaker A: Or just buy Ferrari. Just buy Ferrari because that's the one that bucks the chain, because it is the one that doesn't behave like an automotive sector stock. Right. That's the, that's the point. So I'm glad you raised it. And the other thing I'm glad you raised is that, yes, you would be a trader in this space. So you need to look for releases of information, which is something I forgot to mention with BMW is by the time this podcast goes live, I think the very next day their half year report will be out. So these were Q one numbers. Just wait for that half year report. I cannot wait to see what happened with like Rolls Royce sales, for example. With what we've seen in China. I think it's going to potentially be pretty ugly.
[00:21:56] Speaker B: I think that's going to be so interesting. I also. I'm watching Ferrari to see if Ferrari suffers from the same downdraft that we've seen in other luxury goods players. Because we've always said Ferrari is not an automotive manufacturer, it's a luxury goods play. We've seen pressure on LVMH we've seen pressure on Richemont. Will that pressure actually impact Ferrari as well? That's what I'm going to be looking out for on that particular ticker. Because, yes, it's a great brand. Maybe just buy the actual car, not the stock. The stock's done really well. We'll see when those results come out. That's where we've got to leave it this week, unfortunately. So let us know what you think of the show. Hit us up on social media. It's a pod. One word at finance. Ghost and Uhammad Nallah all on X. Or go and find us on LinkedIn, pop us a note on there. We hope you've enjoyed the show. Until next week, same time, same place. Thanks and cheers.
[00:22:39] Speaker A: Ciao.
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