Pick Up EV Pair Trade: Long GM, Short Rivian On Supply Chain Woes | Seeking Alpha

2022-06-18 18:57:13 By : Ms. Annie Liu

Nic Antaya/Getty Images News

Nic Antaya/Getty Images News

As competition in the EV space heats up between startups and established ICE OEMs transitioning aggressively, picking and choosing an ultimate winner in the EV space in near impossible. However, leveraging opportunities between lofty valuations attached to pure-play EV startups and deep-pocketed, profitable ICE OEMs can provide an interesting, profit-capturing opportunity as the EV industry faces multiple headwinds from supply chain strains and rising raw materials prices. As such, a pair trade idea (potentially constructed with/utilizing options) consisting of going long in General Motors ( NYSE:GM ) and short Rivian ( NASDAQ:RIVN ), albeit risky, could provide an outlet to ride out the volatility within the market and the sector for a quarter or two.

The EV industry is a delicate industry, dependent on a wide variety of inputs and outside forces that it cannot control -- take a look at the week-long trucker strike occurring in South Korea. Hyundai (OTCPK:HYMTF) recorded lost vehicle production of 3,800 vehicles as of Friday June 10, from a strike lasting just four days at that time, nearly 1,000 vehicles per day. Battery manufacturers such as SK On and Samsung SDI did not directly note impacts, but one of the firms warned that it may have to re-evaluate shipments if strikes continue. The truckers on strike "plan to stop shipments of raw materials for semiconductors produced in Ulsan, said union official Park Jeong-tae," although disruptions at the time may not be substantial.

While this is merely a current example of the fragility of the auto industry supply chain, think back to Canada's trucker protest in February, which quickly sent the auto industry shuttering doors and halting production as components were quickly in short supply.

Again, headwinds to the auto and EV industry are of major concern, impacting production and delivery schedules, adding to costs and increasing vehicle prices as OEMs hike prices to offset cost inflation. Let's take a brief dive into two persistent headwinds: semiconductors, and battery metals.

Semiconductor shortages, by this time, should be a relatively common phrase to those familiar with the auto industry. And these shortages have yet to fully clear.

Per the most recent estimate from AutoForecast solutions, the "number of vehicles canceled from automaker production schedules worldwide due to the microchip shortage has surges past 2 million." Automotive News adds that even with "hopeful predictions around the industry, automakers continue prioritizing their available chips for high-end, high-margin vehicles instead of entry-level ones." Consumer Reports says the "global semiconductor shortage continues to squeeze the supply of microchips used to manufacture everything from cars."

Intel CEO Pat Gelsinger said that chip "supply problems would most likely persist into 2024," while Guidehouse Insights analyst Sam Abuelsamid predicts that the chip shortage "will continue well into 2023 at the very least" as the "content of semiconductors in vehicles is ever-increasing, and the shift to EVs is only going to exacerbate that."

S&P Global notes that the "average cost of making lithium-ion batteries used for EVs is increasing for the first time in roughly a decade, largely due to the inflated cost of key metals including lithium, cobalt and nickel." A weathering blow to EV manufacturers, as batteries are among the most-expensive parts to produce and procure; rising prices not only threaten margins, but have been a factor in vehicle price hikes from Tesla (TSLA) and Lucid Motors (LCID), raising the cost of EVs and potentially lengthening the timeline to achieving EV-ICE cost-parity.

Shortages of cobalt and recent surges in lithium and nickel prices (stemming from effects of sanctions on Russian nickel supply) are hampering the path to cheaper batteries and cheaper EVs. Consumers may find a more difficult time finding affordable EVs in the near-term as OEMs struggle to source adequate amounts of both batteries and chips at fair prices.

With that covered, let's dive into the opportunities and challenges facing both GM and Rivian.

GM is blazing ahead with its flagship electric Silverado pickup, recording about 140,000 reservations for the vehicle slated to enter production next year; keep in mind that as an established OEM, GM is not reliant on keeping production schedules and converting orders to the same degree a startup like Rivian is. GM has multiple outlets for growth in EVs -- the Cadillac Lyriq EV sold out in hours, although the exact amount of pre-orders in not concretely known. GM may not be seen as an EV front-runner, especially given the reputation with the original Bolt, but it can't be discounted from either. GM has solid prospects in the EV realm, along with solid fundamentals to support buying at lows in this bout of market volatility.

In terms of the aforementioned headwinds, GM CEO Mary Barra said that she expects the chip shortage to last until 2023, as GM is "still seeing some constraints in products." GM also "said it expects auto production to improve and rise 25%-30% compared to last year." So GM is working on navigating the chip issues, but can capture strong pricing from more limited supply, even as production still has room to improve. When it comes down to EVs, GM is quite well-prepared. Overall, GM has "supply arrangements in place to meet" its production ramp to 400,000 EVs between 2022 and 2023, according to Barra.

Compared to Rivian, GM holds a significant upper hand in production volume off the bat. Rivian is aiming for just 25,000 units in production volume, half of its original 50,000 unit forecast for the year as it faced setbacks from supply chain disruptions and rising materials costs.

Launching into a crowded pickup market with plenty of competition, GM needs volume to secure a leading spot ahead of main challenger Ford. Ford has already closed reservations for its EV pickup, the F-150 Lightning, noting that it has received over 200,000 customer deposits. With 150,000 units in planned capacity, Ford can start to fill orders quickly, so a rapid scale up for GM is necessary to meet strong competition, and well-positioned to perform well in the segment. Barra said GM is "selling every truck we can build," reflective of the high demand for autos and GM's vehicle lineup.

From a financial standpoint, GM is healthy, profitable, and targeting higher-growth, higher-margin opportunities in EVs and software, all factors suggestive of an opportunity to capture upside from this recent low.

As the market continues to falter against the inflationary and rates backdrop, GM looks to offer a bit of a safe haven in the mobility sphere.

Solidifying GM as an interesting opportunity for a long position include:

Although it is navigating a challenging environment, GM looks well positioned to succeed, and a relatively cheap valuation on multiple metrics supports entry at lows, to capture potential 34% upside to $45, or trading at 7x PE and 4x free cash flow as emerging growth trends start to materialize.

On the other hand of the trade sits beleaguered Rivian, which has slashed production volumes and reportedly significantly increased delivery wait times to customers. With little volume running off the line and a strict contract with Amazon limited delivery vehicle growth, Rivian looks to enter a troubling stretch as it starts to scrape the surface with revenue generation.

Rivian opted to reaffirm its production forecast for the year when it reported earnings in May, as executives foresee chip constraints easing by the end of the year. However, Rivian already succumbing to slashed output guidance amid the macro environment suggests that the underlying picture within Rivian's production and component sourcing may be faltering.

Rivian recently surprised customers with a 20% price hike to combat cost inflation stemming from surging raw materials prices -- this quickly, and rightfully so, "caused furious customers to inundate social media with their cancelled reservations." Rivian CEO RJ Scaringe noted that applying the price hike to pre-existing pre-orders "was wrong and we broke your trust in Rivian." Although an apology was due, in my opinion, trust is key -- do customers still trust Rivian to hold on to promises about prices or deliveries?

Time will tell -- Rivian just delayed customers deliveries, with customers noting that an email informed them that deliveries were slated to begin in late summer, or August to September, while others said delivery was "pushed to October-December 2022." Rivian's email cited supply chain challenges and service infrastructure, prioritizing customers in close proximity to service locations to speed up delivery. This raises questions about whether Rivian can scale successfully and rapidly enough to meet even its slashed production target.

With challenges looming, Rivian is a risky pair to GM, but has a handful of key factors involved in a short-term short call:

Given the challenges ahead over the course of the next two quarters, downside potential for Rivian looks elevated, targeting a near-retest of lows around $22, or ~20% downside, as Rivian battles lower-than-expected production and delivery volumes, widening net losses, and difficulties navigating macro challenges in the near term.

Even so, Rivian could be attractive in the long-run if it can quickly sort out its production ramp, generating substantial revenue at ~75,000 units (~$5.9 billion), or about 2x EV/sales. Coupled with a moderate short interest of ~10%, Rivian could see an explosive move upwards if shorts need to cover, enhancing risk to the pair trade. A ~1.15% cost to borrow can allow a short position to be kept open over the course of the next quarter. However, given the potential for a quick burst higher, a pair trade here can be protected via options. Something such as the July 15 calls at the 35 strike, which cost just $65 and protect against 25% upside, can hedge (three calls a likely minimum hedge per 50 shares).

Pair trades are risky, given the short leg, especially more so at a time when the short leg here, Rivian, is trading near lows with a moderately high short interest that may see some strong upward trading in a covering scenario. Hedging via options can mitigate potential losses on the short side should the position move against you, while creating the pair trade completely via options opens up a limited-risk, lower-capital way to find leveraged returns in this scenario.

This article was written by

Disclosure: I/we have no stock, option or similar derivative position in any of the companies mentioned, and no plans to initiate any such positions within 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.