General Motors (GM) recently garnered headlines after investor Warren Buffett's recent 13F filing showed that he purchased 15 million shares of GM during Q2 2013. At the end of the quarter, he owned 40 million shares. This increase of 60% sparked my interest in the company. Also, Harris Associates bought 51.9 million shares in Q2. After researching the company, GM shares are undervalued when compared to their main rival, Ford (F). Also, there are upcoming catalysts for the company that should result in revaluation - new models gaining recognition, sales improvements based on vast improvements in quality, an improving European economy, and an end to the US Treasury, UAW, and Canadian government liquidation of their stake in the company. In particular, I think the conclusion of the treasury sales of GM stock is an under-appreciated catalyst given the performance of companies in similar situations in the past.
Valuations of GM compared to Ford
The inevitable comparison for GM is its close competitor, Ford. The table below shows that Ford has a higher valuation than GM - which has been warranted given their higher profit margins and return on equity in the recent past. Specifically, Ford has had very good publicity for the past several years. Their strategies and new cars have been a hit amongst consumers. Ford's new car quality began to be recognized several years ago and the company has benefited greatly from that as they have been able to build upon the success with continued well-received updates to models. GM is several years behind Ford in this respect. Given GM's low valuation metrics, there is still a significant amount of underperformance priced in. I believe the positive aspects of GM are under-appreciated in the market which presents a buying opportunity for savvy investors.
Return on Equity
Operating Cash Flow
data from yahoo.com
Even with the superior past execution of Ford over GM, the two companies have nearly identical stock performances since GM's IPO in November 2010 - of 0% gains since then. These stocks badly trail the S&P 500's 37% gain over this period. The lack of outperformance of Ford over GM suggests that shareholders believe that Ford's superior quality and execution is a temporary phenomenon where GM can catch up in the not too distant future. Also, both companies' significant underperformance vs. the S&P over the time period show there is plenty of room for catch-up as the outlook for the global economy continues to show signs of improvement.
Signs of improvement in Europe, one of both automakers' key markets should have a positive impact shares. During their most recent quarter, GM noted that the rate of deterioration in Europe had slowed significantly even as auto sales in the region hit a 20-year low. Recently released data showed that the euro zone exited recession in the second quarter. These are positive signs but the region will need to start growing for investors to breathe a sigh of relief and pay a higher multiple for the automakers' earnings overseas. Investors who are long term, value-oriented should get into shares before this happens and GM is the better value of the two.
GM Quality Improvements
This year, Consumer Reports named the Chevy Impala the top rated vehicle of the year. This new-found recognition bodes well for sales of the new models. The Impala improvements will be incorporated into as many of the 18 new models being introduced as possible providing plenty of new features to attract consumers. With this refresh, GM will have one of the newest model lines of any auto maker.
Ford's quality improvements in the 2009 time frame led to a significant run-up in shares which outperformed the industry as a whole over the time period. However, recently they have dropped ratings because of their Sync system. The most recent J.D. Power survey puts them near the bottom of the initial quality rankings while GM has many brands near the top. GM's shares will be revalued over the coming year to reflect the new, better quality products - similar to what happened to Ford a few years ago.
Governments Selling Shares
In December 2012, the US Treasury announced that it would sell their entire 61% stake in GM within 12 to 15 months. Given that guidance, the stake should be dissolved between December 2013 and March 2014. Initially, the US Treasury owned roughly 500 million shares in the company. In December 2012, GM repurchased 200 million shares and the treasury announced a plan to divest the remaining 300 million shares. Since then, roughly 58 million shares were sold in April, 30 million shares were sold in June, and 25 million shares were sold in July. That leaves the US treasury with approximately 187 million shares remaining. At a pace of selling 30 million shares per month, the entire stake should be sold by February 2014. Also, the Canadian government still owns a roughly 10% stake in the company. Reports suggest they have been in discussions to begin selling off this stake in the near future - though they could wait several more years. The UAW-VEBA is also in the process of selling their stake in the company with a recent $171 million warrant offering.
Given all of this selling, there is enormous downward pressure being put on shares. The pace of US Treasury selling - 25 million shares per month is equivalent to twice the average daily volume in new supply coming on the market each month. That doesn't account for the stake being sold by the UAW and potentially the Canadian government. Even with all of this selling pressure, shares are up 19% YTD. This illustrates the significant buying interest in the company.
As the major government and union holders continue to reduce their stakes in the company, the company can move away from the negative perceptions amongst the investing community associated with the heavy government ownership. Also, this negative perception doesn't appear to hold back too many buyers given the company's strong sales figures.
A recent example suggests there is significant upside to shares once the selling pressure of the US Treasury is removed. In May 2011, the US Treasury began liquidating a 92% ownership stake in AIG with the stock trading around $30 per share. By December 2012, the entire stake had been liquidated with the final tranche selling for $32.50 per share. Over the duration of the treasury sales, the stock never traded above $35 per share. In the 8 months since the last sale, shares of AIG have rallied 45% to trade at $47 per share now. I expect significant upside in shares of GM once the constant selling pressure is removed sometime early in CY 2014 similar to what we saw with AIG.
Investors interested in taking advantage of GM's improving product quality, upward momentum in Europe and the end of 'Government Motors' should look into this stock as a value play.
Additional disclosure: I am long GM Series B Warrants.