Morningstar - Q2 2023 - 68

Investors
It wasn't until the last decade that Brazil finally
had airbags as a regulatory safety standard.
Whiston: I'll add something from my coverage list,
Gentex GNTX, which makes auto-dimming
electrochromic mirrors. They're a great company
with amazing margins, probably best in class for
auto suppliers, more like Apple AAPL and
Garmin GRMN margins. No debt, tons of cash. It's
a name I talk about for clients that normally
don't like to invest in the auto industry because
it's both cyclical and capital-intensive. This is
a name that doesn't have much downside risk. For
now, I don't see mirrors being replaced by cameras.
Cameras aren't as perfect as some people may
think they are, for one. And you'd have to change
regulation in the U.S., which takes a very long time.
Lallos: Let's circle back to BMW. It has a moat,
which is unusual for automakers, thanks in part to
its strong brand. How is it faring?
Hilgert: Being a premium car company,
BMW benefits from the pricing environment.
And like everybody else, they're allocating
chips toward the higher-margin products as much
as they can. They do have to allocate to
battery-electric vehicles so that they can be
compliant with their government-targeted
CO2
levels each year, but they've got plenty of
global government subsidies to help them
out with pricing.
BMW will have 13 models electrified by the
end of this year. They're targeting about 50% of
their global volume being battery-electric
by 2030, but they're taking a different approach
than everybody else. They've made their platforms
more flexible so the same car can go down an
assembly line and get any powertrain in the
vehicle. After 2025, the new platform, the Neue
Klasse, being fully digitized and battery-electric
only, will be used as a single platform across all
models. It should lead to a higher margin,
and BMW's already a high-margin company with
one of the best returns on investment capital.
Lallos: Dave, to go a little further afield, what about
CarMax KMX? It's 5 stars right now and has
been affected by the same issues as the automakers.
Whiston: The chip shortage also drastically
messed up the used-vehicle market. This is the key
68
Morningstar Q2 2023
reason why CarMax's stock has gotten decimated.
There's more demand for used vehicles, but not
as many used vehicles to sell. That causes
affordability problems not only for consumers, but
for the used-vehicle retailers. That's something
that doesn't get enough attention. I think people
just assume the dealers are being greedy.
Procurement costs for these used vehicles are
so high, and you can only charge so much.
CarMax's average selling price has gone from
around $19,000 before the pandemic to
around $28,000 now. At the same time, consumers
are getting squeezed. That's caused CarMax's
gross margins to compress by several
hundred basis points. But I like what their
management team is doing. They're not charging
consumers as much as they perhaps could.
They want to create some goodwill and have those
people remember how they were treated
when times were bad and later buy another
car from CarMax.
For someone looking to buy CarMax's stock, do
I think it's cheap? Absolutely. I'm a big fan of that
company. I think their business model is
tremendous. They also have a lucrative financing
arm. I do caution people, though, that this is
probably a better name for someone with a
perspective beyond this year. What you need is to
get the chip shortage over with, so you can get
new-vehicle sales up, which will ultimately
improve used-vehicle supply as well. But that will
take probably well into 2025.
Lallos: Kris, would you single out any automotive name
as a particularly good investment from an ESG angle?
Inton: It's all about the valuation. We're
not adjudicating whether or not the risks are
handled well, but Rich and Dave and the
rest of the analysts are incorporating the ESG risks
into their valuations.
But the one thing I'd highlight in general is that
when we look at the auto sector from both
the Sustainalytics ESG Risk Rating as well as from
the probability-weighted materiality of the
ESG risks that the analysts have incorporated into
the model, it isn't particularly " ESG risky " -
I'll put that in quotes. For example, the automakers
tend to have Medium ESG Risk Ratings,
according to Sustainalytics. The ESG risks that the
analysts have incorporated into their models
for the most part are below the average that we've
observed over the entire coverage universe.
Lallos: Let's touch on Tesla before we wrap up. Last
time we spoke, it was a 1-star stock; now it's slightly
undervalued. I know another analyst covers it now, but
I assume you both keep it in your sights.
Whiston: The big question, at least on the
auto side, is whether they will achieve Elon Musk's
promise of selling 20 million vehicles a year
by 2030. You are talking about double the volume
of Toyota TM and Volkswagen. And now
there's much more competition.
The Mercedes EQS is the one to point to, because
I love the interior of that vehicle. People like to say
Teslas are futuristic-looking spaceships, but
they're also very minimalist. When you look at the
interior of a nice Mercedes and compare it to
even a Model S, it's not the same luxury feel, the
same plushness. Look at what GM's got now with
the Hummer BEV pickup and the Cadillac Lyriq
crossover. Ford has the Mustang Mach-E. Hyundai
and Kia are doing very well in the U.S. with EV
market share. I think Tesla's lead will keep getting
chipped away over time.
Hilgert: Tesla is changing the conversation in
the industry, but not because of its product. It's
changing the conversation because of its
manufacturing efficiency. The company can
produce a vehicle in about 10 hours. Traditional
automakers take 20 to 30 hours. Tesla is using
what they're calling Giga castings, which
essentially combines a lot of the components in
the front end and the back end all in one part.
Tesla is effecting change in the way that Toyota
once did in the '70s, '80s, and '90s. Now everybody
has a version of a Toyota Production System.
Not everybody thinks that Giga casting is the
right way to go, because if something breaks in
the field, then the whole thing has to go,
as opposed to dealing with just a smaller part.
So, we'll see how this develops. But Tesla
has pushed the envelope on how to manufacture
a vehicle. K
Laura Lallos is managing editor of Morningstar magazine.
https://www.morningstar.com/stocks/xnas/gntx/quote https://www.morningstar.com/stocks/xnas/aapl/quote https://www.morningstar.com/stocks/xnys/grmn/quote https://www.morningstar.com/stocks/xnys/tm/quote https://www.morningstar.com/stocks/xnys/kmx/quote https://www.morningstar.com/authors/44/laura-lallos
Morningstar - Q2 2023

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