Old reputations die hard, especially when it comes to companies that had a major fall from grace. Having gone through one of the most public and humiliating bankruptcies in the last decade, General Motors (NYSE:GM) still carries the image, among some mainstream media and retail investors, as a 'bloated' or 'dinosaur' corporation whose cars and business are stuck in the '80s when the world is well into the 21st century. Some felt GM should never have been allowed to be resurrected after the bankruptcy. In addition, a large infusion of taxpayer money as part of TARP, giving it the infamous tag 'Government Motors', has given GM a terrible image problem that will probably take years for it to shed. But all this is a far cry from what's going on with today's GM - folks, the spark is back!
The new GM
GM emerged from bankruptcy as a leaner and stronger company. It is making good cars and trucks that people are buying in droves or at least giving many buyers a serious consideration among the Japanese staples. Fortuitously for GM, Toyota's previously unsullied reputation for quality recently having taken a hit is also helping. The latest announcement that the US Treasury is selling 200 million GM shares back to the company, at a substantial discount to its original purchase price, was well received by investors who gave the stock a 7% jump, making the price close to the agreed deal terms ($27.50/share). GM closed at $27.34 on Dec. 20, a price level briefly touched on Feb. 17, 2012 but really, not seen for the last 1.5 years going back to July 2011 when it crossed this price on its long slide down. Implicit here is the expectation by investors that GM was able to convince the US Treasury that the company is worth at least that much, which the broader market had not realized until then. More valuable from a long-term perspective is that this move allows GM to shake off its 'government motors' image and move towards a market-oriented ownership. So much for all the perception, what about the hard facts?
GM's balance sheet and P&L both show improving health. A slightly higher COGS ratio this year leading to a bit lower gross profit margins (12.1-12.4% Gross Margins for first 3 quarters) compared to 2011 (12.7% Gross Margin) is a sign of improving investments into product quality, and of course, of the broader price increases of raw materials which all auto manufacturers faced. As of Sept. 30, 2012 data, it had $33.7 billion in cash and short-term investments, which works to about $21.50 per share. Is the rest of the company worth only $5.84/share? Put another way, considering GM earned $4.58 per share in 2011, the market is giving GM an ex-cash trailing P/E ratio of 1.27! This does not consider the substantial inroads GM has made in 2012 in all its markets and the improvements in operations this year. So, 2013 will be an even better year for GM as these efforts start to bear full results. Even considering analysts' consensus EPS estimate of $3.71 for 2013, the ex-cash forward P/E ratio is only 1.57 (assuming no addition to its cash reserves from operations). This is for a company that owns some of the top automobile brands in many countries with deep operational strength in several countries around the world. GM may have a 'grandfatherly' image in the U.S. but in China and India, the world's fastest growing automobile markets, GM has well-positioned, aspirational brands and is a nimble player, poised to capture the growth in those markets. There are several good reasons for GM's profits to rise in 2013 and beyond, as Forbes recently pointed out.
Believe in Warren Buffett and David Einhorn
Both these legendary and astute investors have owned GM long since it was knocked down. Berkshire probably bought GM around $23-25 range and Einhorn has reportedly been buying GM on its way down, with a significant position near $20. Both have been proven right so far, especially Einhorn, who made a public announcement on Oct. 4 on his bullishness about GM. Investors who bought right after his announcement would have realized a 12% gain already! I am sure there are many SA investors like me who would have done their due diligence when GM was knocked down to sub-$20 levels. GM's shares traded in July at prices below even the value of its Cash holdings per share (GM in $19's range was a rare opportunity) but even after the run-up, it holds deep value as shown below.
Should you buy GM now?
Investors must do their own due diligence, but here's a simple value analysis for GM. Having gone through one bankruptcy cycle, applying the liquidation value method to GM is not without reason, but let's be clear that the 'new' GM is certainly not anywhere near that.
First, let's look at the assumptions I made in this analysis. I assumed a 50% discount on the book value of PPE (net of depreciation), which easily covers any risk of potential over-valuation of physical assets. Companies like GM have a long-established and validated method of valuing physical assets as close to market as possible, so taking a 50% impairment on that value is very conservative. I have removed the entire Goodwill on its books in calculating the liquidation value. Next, I impaired its inventory by 40%, which is like saying that all its cars and trucks in the assembly lines/warehouses and the raw material as well as WIP components are worth only 60% of their book value. Note that the book value for cars and trucks, by definition, is already lower than the market retail price. So, this assumes a 'fire sale' situation of perfectly good inventory. Receivables have been impaired by 15%, because most banks will lend 85% against receivables, which implies the risk of any payment defaults is fully priced in.
Using the conservative assumptions above, and deducting the full value of long-term liabilities at $44.83 billion on its books, I get a liquidation value of $36.3 per share. When you remove the entire long-term liabilities, I get $64.8 per share. Under a liquidation scenario, it is not inconceivable that the long-term liabilities are hived off to PBGC or they get to take a nice discount on the liabilities, so the real liquidation value will be somewhere between the two figures, i.e. between $36 and $64 a share. Also, GM's pension plan administrators are trying to improve the situation, with China willing to buy its illiquid private equity assets. Still, for a profitable, on-going company like GM, it is safer to assume that the full value of long-term liabilities will remain on its books. Considering this, the liquidation value is still 33% higher than the current price, indicating a good margin of safety. Even valued on traditional P/E metrics earlier, we saw it was quite cheap as well.
For a company that is starting to run on all cylinders (sorry, couldn't resist the pun!), despite the recent run-up, GM remains a deep value stock with a lot of upside potential. If we move away from the perceptual or temporal concerns (fiscal cliff, GM Europe's woes), and look at the hard facts, the company could be a great investment opportunity for 2013. No wonder Warren Buffett and David Einhorn are so fired up on GM.