Target Tanks the Market. Plus EV Stocks.

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We have a position where automakers are going to have to figure out, you know, how many EVs can I lose money on so I could justify the rest of my business? That's, that's not a good dynamic, unfortunately.

Hello and welcome to the Barron's Streetwise Podcast. I'm Jack Howe, and the voice you just heard is Colin Langan. He's an analyst at Wells Fargo Securities who just turned deeply negative on shares of legacy carmakers Ford and General Motors. He's not particularly positive on younger rivals like Tesla and Rivian either. We'll hear why. But first, Well, let's talk about retail wreckage and why this past week was such a clean up in aisle 4 situation for stocks. Listening in is our audio producer Jackson. Hi, Jackson.

Hi, Jack.

We're going to talk about retail in just a moment. You've got some Costco news. Tell folks what you were just telling me.

Yeah, I saw on the internet that Costco had raised their hot dog soda combo from $1.50 to $2.50.

Big jump.

I know. I panicked, but then I looked into it more and that was a fake tweet. So we're good for now.

Still $1.50. Yeah. What a deal. How long has it been at that price?

I think since 1985.

Someone else on Twitter said They showed a picture of that hot dog and soda. They said, this is the only real stablecoin. I think that's a shot about TerraUSD, which is a type of cryptocurrency called a stablecoin because it was supposed to maintain a stable value, but what it really was is make-believe money backed by other make-believe money, and it collapsed, and I'm make-believe shocked. Now let's start with a quick update about the stock market. And before I come to retailers, I want to mention a story that was overshadowed by other events this past week. The best-performing stock in the S&P 500 on Tuesday was Paramount Global. It jumped 15% after Warren Buffett's investment company Berkshire Hathaway disclosed that it had bought a stake. And to me, that begs the question of why Paramount and not Netflix whose stock is down from a peak of $700 to a recent $180 or so. And here's my best guess: Paramount is a combination of two legacy television companies, Viacom and CBS. When they were separate, each was capable on its own of generating well over a billion dollars a year in free cash flow. And that's because traditional TV was and still is a cash cow. Now this year, Paramount is expected to bring in less than $1 billion in free cash flow because it's spending a lot of money on content for its streaming service Paramount Plus. We don't yet know whether streaming will be as profitable as traditional TV, but Paramount makes money in streaming from both advertising and subscriptions. In addition to Paramount Plus, it has Showtime and a free ad-supported streaming service called Pluto TV, plus the Paramount movie studio. If you look at Wall Street's forecast for future years, Paramount is expected to reach more than $2 billion in yearly free cash flow and rising within 4 years. And that seems plenty feasible because, again, the company has made money at that level in the past. Paramount CEO Bob Bakish has been on this podcast a couple of times. This past February, he talked about how traditional TV and movie distribution is an asset, not a drag, because it can help to take some of the risk out of making new shows and movies for streaming. For example, Paramount can introduce a new series on TV before bringing it to streaming, or it can recoup its production spending on a movie using a 45-day theater window before making the movie available on streaming. Anyhow, if you believe the forecasts for Paramount, Buffett has bought into a business that will soon generate a free cash yield over 10% calculated against today's price. Now, Netflix has many more subscribers than Paramount, and you'd have to say it has more compelling content for now based on things like awards.

I don't see how anyone competes with Is It Cake?

Is It Cake? For folks who don't know what that is, give us the elevator pitch. We just got on the elevator. I'm the big shot executive. All right, kid, I don't have a lot of time. I'm only going up to 8, and saying that just took us to 2. So you got 6 more floors. Let's hear your best.

All right, 3 contestants. There's a toaster. They have to guess if it's cake or not cake, and that's it.

I just hit the emergency stop button. I'm so impressed, I want to hear more.

That is not cake.

Oh, that is a taco.

So I also have an idea for a spinoff. It's called Is It Pi?

Okay, so Netflix has this compelling content, but for investors, it's also 4 times the stock market value of Paramount. And over the past 6 years, it's burned through $8 billion in cash. That part's important. We haven't yet seen how compelling Netflix would be if it tried to bring down spending to generate consistent free cash flow. Meanwhile, Netflix's subscriber base is expected to shrink this quarter. Paramount subscribers are still growing. The distant free cash predictions for Netflix are impressive, but they're also highly uncertain. If it turns out that Netflix is a technology company that can rewrite the rules of Hollywood profitability, then today's price might be attractive. But if it's just a show business company that got a head start in streaming and had free license to burn cash for a while, but now must keep content budgets in line with its income, it's possible that legacy players like Paramount or Warner Bros. Discovery could produce better investment results for a while. So maybe Buffett is making a bet that investors have got show business all wrong. That's my guess. We'll see how his bet works out. Now to retail. On Tuesday, the day that Paramount was the S&P's top performer, its worst performer was Walmart. It fell 11%, and that's a big move for a blue chip. It was Walmart's largest one-day decline going back to a fierce stock market crash in 1987. The company's first quarter report came in slightly above estimates on sales, but well below on earnings. Management said that inflation, including higher supply chain and labor costs, had cut into its margins. Its customers, who were hit with higher costs for food and fuel, bought fewer items overall and cut back on non-essential purchases. They even traded down in some grocery categories like beef. Investors have long been watching for just those things, and they seem to take Walmart's report in stride. After all, a year ago, some US shoppers were getting stimulus checks and now they aren't. So the S&P 500 actually traded 2% higher on Tuesday. Now people from all walks of life shop at Walmart. The average customer has a lower income than the average Target customer and low-income folks get hit hardest by inflation. So maybe Target would fare better when it reported earnings the following day. But it didn't. It did much worse.

Market sell-off in progress on Wall Street right now. All appears to be on the back of one company reporting earnings this morning.

Walmart and Target tell us that they were blindsided by consumer behavior changes and costs that absolutely shook retail to the core. Yes.

What the heck's going on? I mean, these companies are posting slight earnings misses, but they're not saying we're never going to sell anything again.

This really encapsulates the pressure, the squeeze that is coming for Target, for Walmart, for a lot of these other retailers.

Shares plummeted 25%, which was also that stock's worst day since 1987. Target missed on earnings by more than twice as much as Walmart in percentage terms. It took a big hit to margins on inventory write-downs and fees to cancel orders from suppliers. Customers simply shop less for things they might want but don't need, what investors call discretionary items. Target was seen as better insulated from inflation because its customer base has higher average incomes than that of Walmart, but that cuts two ways. Target also sells a much higher mix of discretionary items. If shoppers are sticking more to things they need, Walmart might be in a better position. A lot of analysts are now trying to figure out just what went wrong for Target, but I think that misses the point. Investors knew that Target benefited from windfall profits during the pandemic. The company was a mid-teens percentage earnings grower that suddenly increased earnings by more than 40% for 2 straight years. But even so, just last month, Wall Street was predicting a shift to slower but still healthy growth this year and investors had priced the stock at an optimistic valuation of 17 times earnings. Now the earnings estimate has been slashed to a level that reflects a big decline this year but still leaves Target much better off than it was before the pandemic, and investors have priced the stock at closer to 14 times earnings, which seems more appropriate for a mass merchant with healthy but not rapturous growth prospects. Things are returning to normal, in other words. The thing is, there are a lot of blue chip companies that were maybe priced like they're impervious to inflation and a slowdown in consumer spending, and investors took down some of those shares on Wednesday too. Coca-Cola and Clorox lost 7% apiece. Hershey and Campbell fell 8%. Dollar General fell 11% and Costco 13%. The overall S&P 500 lost 4%. I continue to think that long-term investors will do fine in stocks from these levels, but prices could easily fall more in the near term. Goldman Sachs sees a 35% chance of an economic recession within the next 2 years. It says that S&P 500 earnings have historically declined by a median of 13% from top to bottom during recessions, and that the index has historically dropped by a median of 24%. It was recently down about 17% for the year. But if Target can fall 25% in a day, I think a lot of investors are looking at their individual stock holdings and making sure that valuations and earnings expectations both look reasonable. Now let's focus on a different category of stocks that has tumbled— carmakers., and we'll hear from an analyst that recently issued a couple of big downgrades. That's next after this quick break.

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Welcome back. This has been an uncomfortable year for car stock investors, whether they like the legacy players or the electric insurgents. General Motors is down 38%, Ford 37%, Tesla 32%, and Rivian is down 71%. One analyst says this is no time to buy, in the case of GM and Ford, he says it's time to sell. Colin Langan at Wells Fargo Securities recently double-downgraded both stocks. In other words, he took them from overweight straight to underweight without first downgrading them to a neutral or equal weight rating. I reached out to talk about his reasoning. He says he's pretty bullish on demand even if the economy slows because car purchases have been held up for so long by shortages of semiconductors.

I still think demand, because you have a 3-month waiting list typically to get a car right now, there's still a huge pipeline to keep that getting delivered. Where I think the biggest risk for the automakers is going to be pricing and the dealers as well.

Pricing. One of the things that turned Colin bearish on GM and Ford is performing a teardown on a Tesla. A teardown is where you break a manufactured product down to its individual components to for example, learn more about its cost. And Colin learned something surprising about batteries.

Biggest surprise was the battery costs. And the battery costs, which had been around $112 per kilowatt-hour based on the experts that we hired in 2021, had risen to $168, so a 50% increase. I think also more importantly, the raw materials in the battery, which is the real driver of all of that change, went from $62 to $119. You know, we talk about parity at, you know, trying to get below this $100 per kilowatt-hour. Well, that's virtually impossible when the raw materials themselves, before you build a gigafactory and, you know, buy the machines to put it all together.

By parity, Colin means the point at which an electric vehicle is as good of a deal financially as a gasoline one. He puts that at a battery price of $100 per kilowatt-hour. But as you heard, just the raw materials in a battery cost more than that now. Before factoring in the cost of the factory and workers to turn those materials into batteries. So carmakers will either have to sell their electric vehicles at high prices or take losses on them. Hold that thought. Maybe raw material prices will come down, but that's not what Collins sees, at least not right away.

The problem is, you know, through '25, through '30, it's a very tight supply of these raw materials. Given it's such a long lead time to add supply, I think these high prices might be around to stay.

If raw materials for electric vehicles stay expensive for years, companies that already produce those materials stand to benefit, of course. Colin recently upgraded shares of a lithium miner called Albemarle, ticker ALB, to Overweight. By the way, he says he prefers shares of companies that supply car components to those that make cars. His favorite is BorgWarner, ticker BWA, which makes motors, transmissions, and more to make both gasoline and electric vehicles more efficient. Couldn't carmakers simply limit the number of electric vehicles they produce? Well, that's a problem too. For one thing, customers want those vehicles. For another, companies might need them to meet certain regulatory targets.

Here's Colin. And then you look at the regulatory framework and, you know, I think people miss that, you know, EPA and NHTSA put out extremely aggressive standards. Through 2026. The automakers, even if you read the rules, are going to need to sell over 10%, basically, EVs to hit those standards. We have a position where automakers are going to have to figure out, "How many EVs can I lose money on so I could justify the rest of my business?" That's not a good dynamic, unfortunately. That was really the main driver of the downgrades for both.

[Speaker:TREY_LOCKERBIE] Back to the choice that carmakers face, to lose money on EVs or to raise prices. For mass market companies like GM and Ford, Collins says it isn't much of a choice.

So they don't have the luxury of Tesla pricing or the luxury of not being able to advertise the way Tesla does. It's just hard to sell the Silverado EV at over $10,000 more than a regular Silverado. It's going to be hard to get customers to buy that, especially if you're going to need to sell 10% of your vehicles as EVs. I think that's fundamentally one of the big challenges that they're going to face.

Most analysts who cover GM and Ford stock are bullish, so Collins' view is one that stands out from the consensus. He has equal weight ratings on Tesla and Rivian. He says that Tesla has long-term contracts for raw materials like lithium and that it could be hit by higher costs in the years ahead. Collins' larger concern is growth. By his math, when Tesla fully ramps up its new factories, it'll have to sell its Model 3 and Model Y vehicles at levels that approach unit sales of best-selling traditional vehicles like the Toyota Corolla and RAV4, even though the Teslas cost much more. Rivian, which has just begun ramping up production, has a long road ahead, and it could get hit by high battery costs too. McCollum says that it at least has a lot of cash on hand, and it's differentiated itself in the market by focusing on a distinctive pickup truck and SUV UV for outdoorsy folks. I recently drove a Rivian pickup. Lovely vehicle. A neighbor had one for a few days and he took me for a ride and then he let me drive until he realized how slow of a driver I am, and then he took the wheel again and made it go from 0 to 60 in about 3 seconds, which feels a little like you're skydiving sideways. Speaking of which, my only complaint about the vehicle is that I had to enter it almost sideways Dukes of Hazzard style, because I'm tall and the doorway is low. But once I was inside, there was plenty of room and giant screens and what seemed like quality materials. But I'm not much of a car reviewer. For that, you want my pal Al Root, who writes for Barron's. Al has driven the Rivian truck and Ford's new electric pickup, the F-150 Lightning, and a lot of other EVs, I think 14 in all.

Ford Mach-E, Tesla Model 3, Tesla Model Y, Tesla Model S, Polestar ID.4 from Volkswagen, Porsche Taycan, very impressive car.

Al and I spoke about how difficult it must be for startup carmakers to anticipate small but important design details.

Like the Lucid's $160 grand, the first version of the Lucid, the cup holder completely blocks the center console. So if you like, talk about learning. So you got a $160 grand car, you stick your coffee in there, and now you can't touch anything on the center screen.

Al drives a Prius hybrid. He says that if he were buying a new vehicle now based on his test drives, it'd be a pickup.

If I was ordering it today, I would order the F-150 Lightning. I love the backup power. I like to garden. I like to golf, so you throw the clubs in the back. You know, maybe I'll put my dog in the back. The second car I would get would be a Tesla Model Y. That's the crossover. Very nice car. That's the one I took on a 1,000-mile road trip.

So Al likes the Ford, and he says if he were to pick one car stock, it would also be Ford. For anyone out there shopping for a car now, good luck. Prices are high and availability is not great. The good news is that you can probably get a lot for your trade-in.

Cars.com just did a survey of dealers, and we found out that they are paying more for trade-ins now than they did 2 years ago. And 60% of them estimated an increased payout between 11% and 20%. And it's huge, right?

That's Jenny Newman, editor-in-chief of Cars.com. And she says that if you need a car right away, it helps to be flexible on things like color and features. And to be willing to buy immediately.

And if you see a car that you're interested in and you physically see it on the lot, you need to be ready to buy it immediately. There is no time to dither these days because inventory is so low.

Jenny says that if you're not flexible but you have months to wait, you can order a vehicle and get what you want. She says that before buying an electric vehicle, drivers should consider extra costs for things like electrical upgrades if needed. Cars.com just installed what are called Level 2 chargers at 6 of its reviewers' homes.

The price for installation for those 6 homes was anywhere from $1,700 to $6,900.

Electrician is going to love you for saying that. He's getting excited right now. Jenny, by the way, just bought a car and it was an EV. Colin at Wells Fargo says there's still more to learn about the long-term value of EVs.

When you think about the total cost of ownership and stuff like that, people always talk about gas prices, but the biggest cost is really the depreciation of the vehicle. And I do think there's a bigger risk for EVs if the battery doesn't last past 15 years. That puts them at a disadvantage for an internal combustion engine, which on average can last over 20. So if you're thinking of it from an economic perspective, there's still some uncertainty for anyone selecting an EV. Not that that would preclude me from buying one.

Thank you, Colin and Al and Jenny, and thank all of you for listening. Jackson Cantrell is our producer. He's also the creator of Is It Pie? if you're looking to invest a few Costco stable dogs into a can't-miss spinoff. Subscribe to the podcast, rate it, review it, recommend it to loved ones, but keep it a secret from enemies. And follow me on Twitter. That's @JackHough, H-O-U-G-H. See you next week.

Data is everywhere, but is it ready for consumption? Morningstar developed the language of global investment data so you have the right ingredients to help you shine. Morningstar, where data speaks.