General Motors (GM) is a world-class company in the auto and truck manufacturing space. Based on proprietary discounted cash flow analysis done by The Oxen Group, General Motors' shares are a solid HOLD, with an implied price decline of about 10% for 2013. GM is best known for its iconic brands, including the Corvette, Cadillac and GMC. More quantitatively, GM shares trade at about 10.7x trailing EPS and 8.9x forward EPS ... a discount to the market and its peers. While valuation may seem compelling, other bearish fundamental undertones balance out GM's attractive metrics. GM shares should move toward our price target as a result of themes including shaky emerging market trends, developed market trends, vehicle lineup margin compression, product reviews, and recent developments.
GM was founded in 1908 and is primarily in the business of designing, building and selling cars, trucks and automobile parts worldwide. GM also provides automotive financing services primarily through General Motors Financial Company.
GM organizes itself into five main segments: GM North America (GMNA), GM Europe ((GME)), GM International Operations (GMIO), GM South America (GMSA) and GM Financial. GMNA includes sales, manufacturing and distribution operations in the U.S., Canada, Mexico and operations in Central America and the Caribbean, which all represent top market share stakes in its respective geographic regions.
General Motors does have some attractive valuation metrics. The average forward multiple in this sector is roughly 15x and the median is about 11.3x while the company operates with a sub-9 future PE (perhaps for good reason). GM has below average performance metrics, large amounts of outstanding debt, and unattractive appeal since taking government funding. In the category of profitability, GM performs worse than its competitors. The company holds a 12% gross margin, 3% operating margin, and 13.5 return on equity (ROE). Industry average is roughly 22% for gross margin. Closer competitors Ford (F), Toyota Motors (TM) and Nissan (NSANY) have gross margins at 16%, 14%, and 17%. They have operating margins at 4%, 5%, and 6%. F, TM and NSANY have ROE at 142%, 7%, and 11%. The industry average for operating margin is 4% and 15% for ROE. GM lags all industry averages and most of its competition, which makes us believe that its value is what it should be. We do not see its undervaluation as attractive as a company like Ford that is executing at a higher level than GM. See our buy recommendation on Ford here.
Since we have GM at Hold, we believe there are catalyst for upside and downside that balance each other out. There are two main catalysts to watch: the demand for automobiles in North America and development in emerging markets. In North America, GM saw January sales rise 16%. Overall sales are expected to rise around 6% this year, and GM showed a good start to the year. Yet, with shares already having risen 16% in the last three months, we believe a lot of these expectations are now priced in. The company will need continued outperformance of the 6% benchmark or could see corrections.
The other main catalyst for the stock will be its international markets - South America, Europe and other markets. The outlook for these areas is essential in order for shares to move up and down. We believe there are, however, question marks in many areas that continue to make us believe that shares lack a large amount of catalyst for upside or downside.
GMSA, according to the company, is looking for moderate growth and slight market share increases. GMSA will prosper from increasing prices, diversifying its product mix, and implementing its new portfolio. FX, however, may be a slight drag on earnings in the region. In addition to FX, GMSA may also suffer from Venezuelan uncertainty, which is also touched on in the variant section. While South America looks very promising for 2013, Europe continues to be a question mark.
GME may offset the strength in other areas. European GM is looking for an industry decline of 4%. Headwinds for GME include downward pressure on prices and the stronger demand for smaller cars, which equate to lower margins. We look for European issues to continue to weigh on GM moving forward.
GM International Operations (GMIO) is looking for an industry increase of 5% and wants to expand its portfolio in China and the Association of Southeast Asian Nations (ASEAN). Along with the bullish industry increase, GMIO is expecting modest price tailwinds. China, as well, we believe will experience an increase in competitive pricing pressures.
According to data from Car and Driver, a premier automotive news agency, GM has 6 of the top 11 vehicles with the highest sales incentive. This could mean a variety of things, but we are most concerned with how these incentives hurt margins. Additionally, the cars that are using these incentives surprised us. The largest were for the Cadillac DTS and STS, which makes sense as a new luxury car. Yet, the Chevy Silverado and GMC Sierra were also among the highest. While incentives are fine, we are already worried about a mix of small cars to large cars for most manufacturers. On top of this, GM is cutting margins on two of their most important cash cows?
Other data from Car and Driver is not very bullish either. 2012's 10 Best Cars only had one car from GM's portfolio of brands and the 2013 review did not have a single GM car in the rankings. To put these reviews into comparison, Ford had two spots in 2013 and 2012. F has a much smaller lineup as well.
It is tough for any automotive company to create any moat with such heavy competition, but the company does have a slight one in that it has exposure in nearly every segment and country. Yet, competition is rising in emerging markets. The only moats we do see are in technology. The company's Chevy Volt has a small moat, but that is about it.
Revenue and EPS Outlook
GM's US auto sales rose 16% in January. All of GMs brands posted significant double-digit growth figures. The jump in revenues could be a function of increasingly bullish fundamentals here in the USA. The Federal Reserve is adamantly conducting monetary policy as a function of the unemployment rate. As the Fed floods the economy with money, asset prices like homes and stocks inflate and consumers feel more comfortable making large ticket purchases. This is evident in recent consumer borrowing stats for North America. December 2012 saw non-revolving credit surge by the most in 11 years according to economic reports.
Revenues seems to be rising in the whole sector, and GM is not outperforming. Chrysler Group LLC reported its U.S. auto sales rose 16% during the last month and Ford Motor's US new-vehicle sales rose 22% too.
"GM had a solid quarter because customers around the world love our new vehicles and we're also seeing green shoots take hold on tough issues like complexity reduction, pensions and Europe. We are going to keep playing offense with growth products like the Chevrolet Onix, Opel Mokka and Cadillac ATS and continue to systematically address business risks," said Chairman and CEO Dan Akerson
Former GM CEO Ed Whitacre was recently quoted saying, "I think it will create value for GM somewhere down the line." He is referring to the growth engine of the Chevrolet Volt. The Volt started off slow in 2011, but gained traction in 2012. Sales of the electric vehicle were just about 23,400 units in 2012, compared to 7,600 units in 2011. Growing a massive 200%. GM had three other vehicles that saw 200+% growth YoY. These include the Caprice, Captiva Sport, Sonic and the previously mentioned Volt. We believe these vehicles will continue to benefit GM.
Yet, we believe that the growth of many industries does not mask the issues of Europe. Further, as we can see below, even with growth, GM's price is fair to overvalued. We are projecting 50% earnings growth over the next five years, which is in line with many expectations and requires good demand in emerging markets. The problems we can see below are very high levels of debt, high levels of capital expenditures that will continue to move into new markets, and significant shares outstanding.
Price Target Analysis
The following price target was configured through a 5-year projected discounted cash flow analysis. The model projects operating income, taxes, depreciation, capital expenditures and changes in working capital. Using that information, we can project what the company is worth. We can then use that projection and compare it to current prices.
Here is how to calculate price targets using discounted cash flow analysis:
(all figures in millions)
Project operating income, taxes, depreciation, capex and working capital for five years. Calculate cash flow available by taking operating income - taxes + depreciation - capital expenditures - working capital.
Available Cash Flow
Calculate present value of available cash flow (PV factor of WACC * available cash flow). You can calculate WACC, but we have given this number to you. The PV factor of WACC is calculated by taking 1 / [(1 + WACC)^# of FY years away from current]. For example, 2016 would be 1 / [(1 + WACC)^4 (2016-2012).
WACC for GM: 7.93%
PV Factor of WACC
PV of Available Cash Flow
For the fifth year, we calculate a residual calculation. This number is calculated by taking the fifth year available cash flow and dividing by the cap rate, which is calculated by taking WACC and subtracting out residual growth rate. Residual growth rate is typically between 2-6%. 4% is average growth for the industry. Companies with high levels of growth have higher residual growth, while companies with lower growth levels have lower residual growth. This is why higher growth companies tend to have higher PE ratios. We will give you cap rate.
Cap Rate for GM: 6.2%
Available Cash Flow
Divided by Cap Rate
Multiply by 2016 PV Factor
PV of Residual Value
Calculate Equity Value - add PV of residual value, available cash flow PVs, current cash, and subtract debt:
Sum of Available Cash Flows
PV of Residual Value
Interest Bearing Debt
Divide equity value by shares outstanding:
Profit/Value Industry Comparisons
GM is Better Than X% of Industry
GM disclosed in its most recent 10Q that its Venezuelan operation utilizes US Dollars as its functional currency because of the inflation situation there. The government however makes it extremely difficult to get out of Bolivar Fuerte ((BsF) Venezuelan money). According to the SEC document, "The aggregate net assets of our Venezuelan subsidiaries at September 30, 2012 and December 31, 2011 were $742 million and $438 million. At September 30, 2012 and December 31, 2011 other consolidated entities have receivables from our Venezuelan subsidiaries of $413 million and $380 million. The total amounts pending government approval for settlement at September 30, 2012 and December 31, 2011 were BsF 2.3 billion (equivalent to $545 million) and BsF 2.3 billion (equivalent to $535 million), for which some requests have been pending from 2007." This is a risk to the GM stork because the Venezuelan government recently decided to devalue its currency by 46% and many other countries seem to be on the same path.
Another major risk to the story includes a better than expected EU. The European economy is one of the most hotly debated situations. Eloquent arguments for and against growth can be made. Given that The Oxen Group has a HOLD on GM shares, momentum either to the upside or downside may present a risk. A muddling economy is basically reflected in the HOLD.
The Bottom Line
GM is an excellent automotive stock, however given the fundamentals ... there are better socks to buy in the industry.