In the global transition to electric vehicles (EVs), traditional automakers are grappling with significant challenges, as demonstrated by the situation in China. The nation's increasing adoption of battery-electric vehicles, expected to account for approximately 25% of new car sales by the end of 2023, up from just 4% five years ago, has favored companies like Tesla (NASDAQ:TSLA) and BYD (SZ:002594). These firms have capitalized on the shift, becoming among the world's most valuable car manufacturers.
However, this transition has not been as favorable for traditional Chinese automakers that primarily produce gasoline-powered vehicles. From 2019 to 2022, these companies experienced an average operating profit margin of about 5%, but this figure dropped to less than 3% in 2022. Even though total industry sales volumes are predicted to reach near-record levels in 2023, profit margins are only expected to rise to around 4%.
The decline in profitability is largely attributable to the shrinking market share of gasoline-powered cars. Sales of such vehicles in China are projected to decrease by more than 20% from five years earlier to approximately 17 million units in 2023. This reduction in volume results in unused factory capacity and inefficiencies that adversely affect profit margins.
This scenario poses a complex issue for Ford Motor (NYSE:F) and General Motors (NYSE:GM). Without substantial investments in EV technology, they risk losing market share and further erosion of profitability. However, heavy investment in EVs — a strategy both companies are currently pursuing — does not guarantee success against new entrants like Tesla and Rivian (NASDAQ:RIVN) Automotive. Failure to produce popular EVs could lead to a loss of market share and diminished profitability.
Investors appear cognizant of this predicament. Both GM and Ford stocks are trading below recent averages, with GM at less than five times estimated 2024 earnings and Ford at less than seven times. This may indicate a cautious, wait-and-see approach to how the market evolves.
Despite these challenges, it's becoming increasingly difficult for legacy automakers to ignore the trends. With EVs improving in quality, decreasing in cost, and receiving support from environmental policies worldwide, it's evident that Ford and GM must invest in this technology to stay competitive. They need to ensure their traditional car customers choose their EVs as more American consumers consider switching to electric.
In recent trading on Friday, Ford shares remained nearly flat while GM shares rose by 0.9%. Both stocks have been more influenced by labor developments than EV trends recently, following the expiration of a four-year labor agreement which has led to strikes at some facilities.
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