General Motors (NYSE:GM) and other car manufacturers like Ford Motor (NYSE:F) and Toyota Motor (NYSE:TM) still seem to be a good deal for investors. The companies trade cheaply at multiples of 8-10 times forward earnings and low P/S multiples (see valuation section below). Furthermore, large-cap auto manufacturers hold massive amounts of cash on their balance sheets: General Motors holds about $19 of cash per share while Ford Motor holds about $6 per share. I expect that this gigantic cash position will eventually be returned to shareholders once the government exits its GM investment.
In December 2012 the U.S. Treasury announced that it intends to sell its existing GM stake over the next 12 to 15 month (original press release here). Part of the shares held by the U.S. Treasury were purchased by General Motors and other blocks were sold in the open market. As such, the exit of the U.S. government's GM investment has significant parallels to its investment in American International Group (NYSE:AIG). The government also held a significant amount of shares in AIG (92% of common stock at some point) but managed to sell the shares in a combination of open market transactions and direct sales to the insurance company. Investors reacted worried to the announced share sales and the return of AIG to private shareholders because large amounts of shares were supposed to hit the market (remember the discussion about 'share overhang'). I always found this logic to be ridiculous because the underlying value of the business wasn't affected by this transaction at all and I was heavily in support of AIG's repurchase program which allowed the company to repurchase shares from the Treasury at half book value which in turn was hugely accretive for shareholders. Investors also were way too focused at the time on the selling price of the common stock because everyone assumed a price of $28.72 per AIG share would be required for the U.S. Treasury to break even. All that turned out be completely bogus and shares are now trading at $50 per share (74% up over the break-even price). I believe that General Motors will be no different here. Share overhang discussions are making investors concentrate on short-term events instead of making them focus on the long-term potential of the company.
This discussion is currently repeating in the case of General Motors. On November 21, 2013 Reuters reported:
Treasury on Thursday said it had completed the sale of 70.2 million shares of GM stock and to date had recouped $38.4 billion from the $49.5 billion taxpayer-funded rescue of the Detroit company.
At current prices, Treasury would recoup another $1.2 billion from its remaining stake of 31.1 million shares, bringing its total recovery to $39.6 billion. Treasury said its initial cost basis for the GM shares was $43.52 per share.
In any case, an exit of the government's GM investment should provide further tailwinds for the company. With the government out of the picture, executive compensation structures can be implemented to better incentivize management to deliver value for shareholders. Also, a large part of General Motors' cash position will be up for discussion. I expect that significant amounts of cash will be returned to shareholders in form of share buybacks and dividends.
The initiation of a regular dividend payment also should attract new investor segments which will provide additional support for GM's share price.
The catalysts described above come in addition to a low GM valuation. Just like the entire large-cap car manufacturing sector, valuations of U.S. car companies are very low especially after considering the huge cash balances currently held on their balance sheets.
General Motors is up 53% over the last year despite the ongoing discussion about 'a share overhang' which is more appropriate for a Wall Street analyst get-together. It certainly distracts investors to focus on the things that matter: The long-term earnings prospects of the company.
Over the last two years Toyota Motor has performed the best with a return of 87%. General Motors came in at 84% and Ford Motor at 57% (Ford has hugely outperformed the car manufacturing sector with a five-year return of 527% so its short-term underperformance is clearly forgiven).
General Motors is still the cheapest large-scale auto manufacturer in the field. GM trades at just 8.39 forward earnings but manages to achieve a much lower ex-cash P/E multiple. Ford Motor, which posted record sales during 2013, trades only at 9.31x forward earnings and Toyota Motor at 9.88x. I believe that car manufacturers with global, profitable operations can be trading in the region of 15 times forward earnings. Especially emerging markets offer huge potential for GM and Ford as U.S.-based car companies to deliver growth. The following two graphs compare current P/E and P/S multiples of General Motors, Ford Motor and Toyota Motor.
The table below summarizes the results from above and gives further information about premiums and discounts to the peer group average ratios P/E and P/S. The bottom line is that U.S. car companies still trade at valuations that are significantly underestimating their earnings potential.
A government exit of its General Motors investment should make for a meaningful catalyst similar to the one for American International Group. The company also holds substantial amounts of cash on its balance sheet which provides investors with a significant margin of safety. Ultimately, those cash balances will be up for discussion and need to be deployed. My guess is that a substantial part of it will be used for share buybacks and a dividend initiation. A resumption of dividend payments could be another strong catalyst going forward. In addition, GM posted quite significant improvements in profitability and car sales over the last couple of years. In fact, GM's U.S. car sales were up 16% in October y-o-y. GM remains a strong long-term BUY on low absolute and relative valuation, government exit, possible dividend initiation and booming car sales.