General Motors: The Stars Are Aligned For A Double

By Tim Travis:Disclosure: I am long GM. (More...)

General Motors Co. (GM) offers an extremely attractive valuation, an improved cost structure, and the company is set up for robust growth and earnings potential over the next several years. Interest rates are at record lows, while the average age of existing vehicles is right around 11 years, meaning it is time for a refresh. Housing prices have improved beyond most analysts' expectations, but clearly the global economy is very weak. GM is in the process of its biggest product transformation in decades and signs of increased market share are beginning to become clear, yet market participants value the business at an absurdly low multiple. While high-CAPEX and cyclical businesses aren't my ideal buy and hold investments, General Motors presents the rare opportunity to potentially more than double your money in 3-5 years, with a very reasonable margin of safety. For long-term investors that are willing to see the forest through the trees, GM is an extremely strong buy.

2012 marked a second strong year for General Motors, with net income attributable to common shareholders of $4.9 billion, or $2.92 per fully diluted share. This was down from 2011 when the company earned $7.6 billion, or $4.58 per fully diluted share, due largely to unfavorable special items. Revenue increased 1% to $152.3 billion, from $150.3 billion in 2011. Adjusted EBIT was $7.9 billion in 2012, down from $8.3 billion in 2011. Full-year EBIT-adjusted for 2012 does include the impact of restructuring charges of $(.4) billion. Importantly, free cash flow improved to $4.3 billion from $3.0 billion in 2011. This fee cash flow generation is ultimately what will set the stage for GM to continue improving its balance sheet and buy back stock down the line. GM ended 2012 with $37.2 billion of total automotive liquidity, while automotive cash and marketable securities were $26.1 billion.

One of the biggest issues hanging over General Motors is the company's underfunded pension plan. Fortunately, GM's U.S. defined pension plans earned asset returns of 11.6% in 2012 and ended the year 84% funded. At year-end the pension was underfunded by $13.1 billion, but the company has no mandatory contributions to U.S. defined pension plans for at least 5 years. Across the entire company, GM has $35.6 billion in underfunded pension and other postemployment obligations. Like many other U.S. manufacturing companies with legacy pension obligations, GM has been hindered by the fact that record low-interest rates pressure the projected investment returns versus the company's obligations. When interest rates increase, the gap should close materially, and GM certainly has the wherewithal to make voluntary contributions to reduce the uncertainty.

In the 4th quarter of 2012, GM grew revenue by 3% to $39.3 billion from 2011. Net income attributable to common shareholders was $.9 billion, or $.54 per fully diluted share, including a net gain from special items of $.1 billion or $.06 per fully diluted share. This was compared to the 4th quarter of 2011, where GM's net income was $.5 billion, or $.28 per fully diluted share, including a net loss from special items of $(.2) billion, or $(.11) per fully diluted share. EBIT-adjusted was $1.2 billion in the fourth quarter of 2012, up slightly from $1.1 billion in the 4th quarter of 2011. 4th quarter EBIT-adjusted for 2012 includes the impact of restructuring charges of $(.2) billion. GM's 4th quarter 2012 special items had a $.1 billion impact to net income and includes a $34.9 billion non-cash benefit from the release of the majority of the company's valuation allowances on U.S. and Canada deferred tax assets, and an associated $(26.2) billion non-cash goodwill impairment charge; a $(5.2) billion non-cash impairment of GM Europe long-lived assets; and a $(2.2) billion charge related to U.S. salaried pension plan actions announced earlier this year, among other smaller items.

GM North America (GMNA) continues to be a tremendous source of strength for the company, reporting EBIT-adjusted for the 4th quarter of $1.4 billion, down from $1.5 billion in 2011. For the full-year EBIT-adjusted was $7.0 billion in 2012, down slightly from $7.2 billion in 2011. GM Europe reported EBIT-adjusted of $(.7) billion in the 4th quarter of 2012, compared to $(.6) billion in 2011. Full-year EBIT-adjusted was $(1.8) billion in 2012, compared with $(.7) billion in 2011. General Motors (GMIO) reported 4th quarter EBIT-adjusted of $.5 billion, compared to $.4 billion in 2011. Full-year EBIT-adjusted was $2.2 billion in 2012, up from $1.9 billion in 2011. GM South America (GMSA) reported EBIT-adjusted of $.1 billion in the 4th quarter of 2012, up from $(.2) billion in 2011. Full-year EBIT-adjusted was $.3 billion in 2012, improved from EBIT adjusted of $(.1) billion in 2011. GM Financial posted earnings before taxes (EBT) of $.1 billion in the 4th quarter of 2012, compared with $.2 billion in 2011. Full-year EBT was $.7 billion compared with $.6 billion in 2011. GM Financial will become an increasing source of strength after the acquisition of Ally's operations in Europe and Latin America, along with its joint venture interest in China. After these deals close in 2013, GM should be able to provide financing in markets that represent 80% of sales volume, up from 30% today. Auto financing is an attractive business, as seen through the Great Recession, when many people held on to their cars over their houses if they were lucky enough to have a job.

GM is currently in the midst of one of its most aggressive launches of new lines of cars across the globe in the company's history. In South America, the company is betting heavily on the Chevrolet Onix, which should help the company grow adjusted-EBIT in the region from 2012. In North America, GM revealed the all-new 2014 Chevrolet Silverado and the GM Sierra full-size pickups. In total, GM is bringing 23 new products to market between 2012 and 2016, while at the same time the company is focusing on rationalizing capacity, and improving its cost structure. Developing these product lines requires aggressive capital investment, which impairs earnings, and I believe that the market is underestimating the vast improvements in GM's competitive product lines across the globe. U.S. automobiles are more competitive than they have been in well over a decade, and I believe that we are still in the early stages of this revitalization and acceptance in the market place.

Europe has been an unmitigated disaster but present management has delivered nicely on most of its goals, so I'm optimistic that the company can achieve a break-even EBIT adjusted by mid-decade. While I certainly understand that GM gains a lot by having a European car line, as far as keeping up with latest technologies and getting the full benefit of procurement through scale, I believe the company did miss an attractive opportunity to divest the business through the bankruptcy process. Opel has notoriously been the sick-man of European car manufacturers and the staggering losses have significantly hurt GM's financial results. If the company had divested the business it could possibly have re-entered Europe by now through acquiring another manufacturer, or at least buying a large stake in one at the depressed valuations many European auto manufacturers are trading at. GM's joint-venture with PSA Peugeot to combine purchasing and logistics should help the company achieve its breakeven goal in a few years, but robust profitability looks like a distant dream. People said the same thing about Chrysler in the U.S., but in Europe it is much more difficult to get the labor force cuts and plant closures, which are necessary to rationalize the business for a depression-like European economic climate.

Judging by GM's automobile sales for the first 3 months of 2013, the year should continue to be a very strong one for the company. In March, GM had sales of 245,950 vehicles. This was the best March in 5 years and the 3rd consecutive month of higher retail and total market share. The company estimates that GM's total share was up about .5 points in the quarter. Cadillac and Buick sales were very encouraging in March, with sales up about 50% and 37%, respectively. At Chevrolet, SUVs and crossover are seeing improvement with the Tahoe, Traverse and Equinox all seeing growth. The Tahoe was up 39% and the Equinox was up 5%, while the Traverse saw a whopping 54% sales increase. The Cruze and Malibu lines have the opportunity to win back market share with updated looks and features.

For the full-year 2013, GM expects operating profit to rise modestly, led by increases in global market share and improved pricing. I believe GM could potentially earn around $4-$4.50 per diluted share in 2013, and in-excess of $5 in 2013. General Motors ended 2012 with 1.675 billion diluted shares outstanding, so at a recent price of $28.37, the stock has a market capitalization of roughly $47.5 billion. Excluding legacy obligations, GM has a consolidated net cash position of $11.3 billion, or roughly $6.70 per share. On December 19th, the U.S. Treasury announced that GM would buy back 200MM of the Treasury's 500.1MM shares and the Treasury will sell the rest of its stake in an orderly fashion over the next 12-15 months. The company also has Series A and Series B preferred shares, in addition to warrants, which ultimately will increase the share count. I believe it would be highly attractive if the company continues to buy back more of its stock from the government to at least offset the dilution. Assuming the company earns $4 in 2013, GM's stock trades just over 7 times this year's earnings, which equates to an earnings yield of 14.2%. Free cash flow should grow over the next several years, which will allow the company to both reduce its long-term liabilities and return capital to shareholders. Within 3 years, I believe GM is more than capable of generating $6 of earnings per share and a simple 10 multiple would put the stock at $60. If U.S. auto sales eventually eclipse 17MM or 18MM on a more normalized basis, $6 a share in earnings seems to be very manageable, particularly when you look at the growth in China.

Clearly, I'd recommend buying the stock but Mr. Market has put quite a big volatility premium on GM put options. This is reflective of the volatility in the stock price and the perception of GM as a "risky" business, which I firmly believe to be out of line with the current business reality. One strategy that an investor could use to generate income and reduce risk, at the cost of less upside potential, is to sell puts on the stock. The January 2015 $30 puts are going for roughly $6.00 per contract. Assuming GM's stock expires above $30, the investor will pocket $600 on $2,400 of risk, for a 25% return on the maximum risk. On an annualized basis, this equates to about 14.2%. With a breakeven of $24 assuming the stock expires below $30, the upside could easily be 250-300% over the long-term. Market participants should be weary when such lofty numbers are used, but GM has a ton of hair on it, including government ownership, and is not too far out of the bankruptcy process, and this is where one can find such large disconnects between price and value. I fully expect volatility but these opportunities don't come around too often, so wait at your own risk.