On Monday, shares of General Motors (GM) rallied 1.8% on news that the Treasury was about to fully exit its stake in the company. After the bell when the Treasury disclosed that it indeed had, shares popped another 0.8%. GM is officially no longer "Government Motors," which has Wall Street cheering, especially because the company no longer has to follow TARP rules on executive pay and dividends. But with the government finally out of GM, is now the time to get in? I don't believe so.
The bull case for GM is easy to see with the government out. Within the next three months, it is all but assured that the company will start a dividend. The company has $28.5 billion in cash and cash equivalents and has generated operating cash flow of $9.5 billion in the first nine months of the year. For comparison, Ford (F) only carries $14 billion in cash with $10.1 billion in operating cash flow. My guess is that GM will want to start the dividend comparatively low and leave room to consistently grow it, earnings status as a "dividend grower."
Using the Ford model, that company started with a small $0.05 dividend, which it doubled a year later. With its cash on hand and cash flow, GM could probably afford a dividend that costs $2-3 billion. I would expect them to start at half of their capacity, resulting in an annual payout of $0.70-$1.00 for a roughly 2% yield. While I recognize the return of capital to shareholders catalyst, I struggle to see a compelling reason to buy GM here.
In particular, GM continues to have problems in Europe. After working tirelessly for years to develop Chevrolet as its leading global brand, the company has done a total about face (press release here). It will drop Chevy almost entirely from Europe by 2016 (keeping only specialty brands like the Corvette) and refocus on Opel. While improving, GM simply has too much capacity in Europe and has been ill-equipped to compete in the fragmented market. Last quarter, it still lost $200 million on the continent. In my estimation, GM should lose $400-$500 million in 2014 in Europe while Ford breaks even or generates a slight profit.
In the past decade, GM has gone from focusing on Opel to Chevy to Opel once again, which has sent a mixed message to both consumers and investors alike. In addition to recording one-time charges of $700-$1 billion due to the change, this transition will make 2014 and 2015 messy years. Whether consumers will be interested in buying a brand that won't exist in their market in two years is an open question. It is also expensive to carry so many brands. Under CEO Alan Mulally, Ford has been able to expand operating margins thanks to its One Ford model where it builds cars to sell everywhere. This simplifies manufacturing and cuts overall R&D spending. GM is taking a step back and re-fragmenting its business, which should exert downward pressure on margins. While Ford has turned the corner in Europe, GM still faces stiff challenges and a major brand overhaul.
In America and China, GM will continue to perform well just as most automakers are thanks to underlying strength in the economy. GM will perform very well ex-Europe in 2014 and 2015, but that region will weigh on results for the foreseeable future. Perhaps reflecting these challenges, GM shares do trade at a reasonable valuation. Next year, GM should earn $4.50-$4.70 ex-items, giving it a forward multiple of 8.9x. Many might be tempted to say that this valuation outweighs the problems in Europe and GM is a buy. In a vacuum, I see why investors are bullish on GM, but there is a whole market of stocks. In other words, while objectively cheap, GM could be relatively expensive.
Next year, Ford should earn $1.80-$1.85, meaning that it only trades 9.05x earnings. Basically, GM and Ford have the same valuation, even though Ford has better margin capacity and is two years ahead of GM in Europe when it comes to profitability. Now, I believe the speculation that Alan Mulally is headed to Microsoft (MSFT) has weighed on shares of Ford as the following chart shows:
After trading in virtual lockstep prior to Steve Ballmer announced his retirement, shares of GM have left Ford in the dust. The hallmark of a great leader is the ability to build a team of able-bodied successors. If you like me hold Mulally in high regard, one has to believe he has a team that can execute on his strategy if he chooses to leave. Moreover, at Ford, the hard work has been done. Capacity has been cut, One Ford has been implemented, Europe is on strong footing, and the company is finally growing in emerging markets.
Over the past month, shares of GM have moved up in almost a straight line as investors saw the end of the Treasury's ownership. Now that this moment has happened, it is prudent for investors to sell their GM holdings and rotate into Ford. For investors who missed the run, I think they are late to the GM party and will be much better in F. GM and Ford have the same valuation, but GM has margin challenges and problems to fix in Europe. When I can buy a better company for the same price, I do. I would sell GM and buy Ford.