General Motors – Ready for the Ride Up?
GM’s discounted valuation compared to Ford and the improvement in the global outlook for the automobile industry leads us to believe that GM promises significant upside at current prices
The General Motors Company (GM), commonly known as GM, is the largest automaker in the US. It deals in the designing, manufacturing, and marketing of cars, trucks, and automobile parts around the world. The Detroit-based company sold over 9.7 million vehicles in its 2013 fiscal year (FY13; ended December 31, 2013), closely trailing the Japanese automobile giant Toyota Motor Corporation (TM), which is the world’s largest automobile company.
Following the drop in vehicle sales after the 2008 financial crisis, GM had filed for a government-led bankruptcy. Consequently, the US Treasury had taken control of almost three-fourths of the company shares, and in return had injected cash to save GM from complete collapse. The automaker then underwent major restructuring, which included the elimination of many of its loss-making car brands, including Pontiac and Oldsmobile, from its portfolio.
GM emerged from government-sponsored bankruptcy in 2010 with one of the largest-ever initial public offerings (IPOs) in the history of the automotive industry. Since then, the company has seen its vehicle sales rise at a compound annual rate (CAGR) of 5%.
General Motors’ Business Segments
The company operates four business segments: GM North America (GMNA), GM Europe (GME), GM International Operations (GMIO), and GM South America (GMSA). Additionally, the company provides automotive financing services through General Motors Financial.
A closer look at the company’s revenues streams shows that sales in Europe have declined at an average annual rate of 2% for the last four years. On the other hand, the company’s International Operations segment has averaged an increase of 8% in the metric over the same period, taking the lead as the company’s fastest-growing segment. GM’s Latin American business registered flattish growth, while unit sales in North America rose as the automobile industry, driven by pent-up demand in the US, rebounded to pre-recession levels.
General Motors’s international segment has witnessed the highest sales growth over the last four years
GM Europe (GME)
GM reported losses of around $800 million for FY13 in its European business, an improvement of about 40% compared to the $1.9 billion loss reported for the said division for the preceding fiscal year. The decline is reflective of the fact that the company has improved its performance in the region.
But the Western Europe car market is forecasted to register a decline in sales in the ongoing fiscal year. GM’s business in the region is projected to close deals for only 12 million units, 1.2 million units down from the levels recorded last year. The decline in sales has been forecasted based on the reduced spending power in the region and challenging macroeconomic conditions in that specific part of the continent. GM has already substantially downsized its European business.
GM Europe announced in December 2013 that the company plans to stop selling its Chevrolet brand by the end of this year so that resources can be freed up to increase focus on the Opel and Vauxhall brands. The division subsequently recorded restructuring charges of around $600 million for the fourth quarter (4Q) of FY113, and will book another $300 million under the head in the first half of FY14. The company expects to free up resources so it can devote them to capturing greater share in emerging markets.
Europe's share in GM’s revenues has been steadily declining over the past six years. Revenues from Europe made up 17% of the company's total revenues in FY11, 13.8% in FY12, and 13% in FY13. A recovery is evident, though, since revenues from GM Europe declined just 2.8% during FY13 after a reported decline of 17.75% in FY12.
The company's management is aiming to break even in Europe by the end of next year.
Emerging Market Growth
GM’s sales in emerging markets have been growing at a much higher rate compared to sales in developed markets. For example, vehicle sales in China have registered an average annual increase of 15% over the last four years. The company has also taken initiatives to increase its market share in developing markets like India and Thailand, and these regions are likely to contribute toward sales growth in FY14 and FY15.
GM has also been able to expand its margins since the financial crisis. Gross margins had swelled to 13% in FY13, up from 8% in FY12; while operating margins had also improved sharply from -2% to 4% over the same time period.
Sell Side Expectations
Sell side analysts are largely bullish on GM’s prospects, especially now that the company no longer carries the moniker of "Government Motors."
In a recent poll by Bloomberg, 18 out of 24 analysts rated the stock as a buy, six gave it a hold rating, and none of the analysts recommended it as a sell.
The 12-month target price for the stock is $46, representing a 28% upside from its current price of $36. Bullish estimates point to an even higher target price of $52 a share, while analysts with bearish evaluations expect GM share price to move down to $33.
Analysts are expecting GM’s bottomline to expand 21% to $9 billion in FY14. For FY15, earnings are projected to increase 28%, while EBITDA (earnings before interest, taxes, depreciation, and amortization) is expected to be $11.6 billion.
GM stock is currently trading at a one-year forward price-to-earnings (P/E) multiple of 8.9x, higher than its five-year average of 7.3x, but lower than Ford (F)’s one-year forward P/E multiple of 10.5x.
GM’s EV/EBITDA multiple, which is 2.7x, is also lower than Ford’s EV/EBITDA multiple of 4.6x. Furthermore, GM has a lower price-to-sales ratio (0.32x) compared to Ford’s ratio of 0.4x, which makes the stock less expensive in all respects compared to its closest competitor, Ford.
The comparison of their valuations leads us to believe that General Motors stock is currently valued relatively cheaply. Investors should really give this stock weight if they are seeking exposure to the automobile industry.
In its latest quarterly earnings release, GM’s management announced the company would reinstate dividend payments to shareholders after the government completed unloading its remaining stake in the company. GM announced a quarterly dividend of 30 cents a share in January 2014, its first dividend in nearly six years. The current payout translates into an annual dividend yield of 3.3%, based on the company’s share price of $36.2.
Dividend investors looking at the sustainability of shareholder payouts will be satisfied to know that the company’s free cash flows (FCFs) have increased at an average rate of 25% over the last three years. Cash flows from operations have also risen 22% during the same period.
In FY14, analysts expect GM’s FCFs to increase 10-15%. The company’s payout ratio, on the other hand, is expected to rise to 35%, and remain lower than Ford’s comparable payout ratio of 42%.
GM’s total liabilities as a percentage of shareholder equity have increased over the past three years, almost doubling between FY12 and FY13. The increase is attributable to the company’s initiatives to expand production and make strategic investments in international markets. The company’s total debt currently stands at $36 billion, but this should not concern investors, who should instead be focusing on the fact that the company is sitting on a cash pile of $28 billion, is generating healthy cash flows, and has experienced strong demand that will help it sustain current sales levels.
Although GM missed analysts’ earnings estimates for 4QFY13, its balance sheet and earnings, as well as its fundamentals, all seem to be improving. We expect the company's restructuring plans in Europe will reduce the negative effect the region has on the overall results of the company.
GM’s recent profitability ratios suggest an ongoing improvement in the company’s operational efficiencies. We expect the record number of car launches and rising domestic demand for automobiles this year to continue to drive car sales around the world, but the company’s North American segment to register the highest improvement in sales.
GM’s cheaper valuation compared to Ford’s, along with the improvement in the global outlook for the automobile industry, leads us to believe that an investment into GM will reap strong returns moving forward. We rate it as a buy.