On Tuesday afternoon, General Motors (GM) declared its first quarterly dividend since emerging from bankruptcy with a $0.30 quarterly payout (press release here). At Tuesday's close, GM is now yielding 3%. After the government sold its remaining shares in the auto giant, the path was clear for the company to return capital to shareholders given strong profitability and a rock solid balance sheet that has $28.5 billion in cash and $32 billion in debt. After this announcement should investors buy shares of GM?
While I expected GM to declare a dividend, the magnitude of the dividend surprised me. I expected the company to follow the Ford (F) dividend reinstitution model. Ford started with a small dividend of $0.05, which it has raised dramatically as results stayed robust to the current $0.125 level. GM decided to forgo the ramp-up and started its dividend at a strong level. This is likely because GM's balance sheet is stronger than Ford's was when Ford restarted its dividend two years ago. After Ford's most recent hike, its shares yield 3.1%, so GM has basically brought its payout to the same level.
In 2014, I expect GM to earn $4.50-$4.70, so the company will have a payout ratio of about 25-27%. In other words, the company has room to grow its dividend more over time. I expect Ford to earn $1.60-$1.65 in 2014, which gives that company a dividend payout ratio of about 31%. Based on Tuesday's close, GM has a forward earnings multiple of 8.7x while Ford is trading at 10x earnings. Overall, GM offers slightly less yield but pays out a slightly smaller proportion of its earnings and trades at a less expensive multiple than Ford.
After this dividend announcement, it might now seem that GM is the better play in the auto sector than Ford, but I have to disagree. Given the choice of investing in GM or holding cash, I would pick GM because its multiple is attractive, and the dividend is an added bonus. However, investors are not faced with such a choice. Investors need to ask if they want exposure to GM in their portfolio or if another stock makes more sense. While Ford may trade at a slight premium to GM, I believe Ford deserves this premium and makes more sense at current levels. The wisest trade would be to sell GM on news of its dividend and invest the proceeds in Ford.
First, investors should be concerned about General Motors' strategy in Europe, which has been muddled at best. For about five years, GM tried to make Chevrolet a global brand that would be GM's flagship in every market. In Europe, GM invested in replacing Opel with Chevy, but the company has recently announced an about-face. GM is pulling Chevy out of Europe and will replace it with Opel by 2016. In the past decade, GM has gone from Opel to Chevy and back to Opel, which has confused consumers and diminished brand value on the continent.
While trying to build a brand Europeans actually want, GM has been slow to cut capacity to deal with the fact that European auto volume will stay slow for some time. Last quarter alone, it 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. You see, Ford started cutting capacity in Europe two years ago and is at roughly the right place. In Europe, Ford is about two years ahead of GM on the capacity front. Further, the company has avoided brand issues with its "One Ford" strategy whereby it sells cars globally rather than fragmenting brands by region. This strategy makes manufacturing simpler, R&D less expensive, and marketing more cohesive, which leads to higher operating margins. GM has been adrift in Europe and is re-fragmenting its business while Ford has been pro-active in Europe and is poised to simplify its business going forward.
Second, Ford's premium is really illusory. For Ford, 2014 is a transition year as it is launching 23 new products. These launches will defer sales into 2015 when Ford will likely earn at least $2.00-$2.10. If normalized for its record slate of new products, Ford would likely earn $1.80-$1.85 in 2014, giving it a normalized multiple of 9x only 3.4% higher than GM's value. Further, these products show that Ford continues to lead GM in innovation.
In particular, Ford has boasted the top selling truck, the F-Series, in America for 27 years. GM has tried to gain share in the lucrative truck market where profit per vehicle is $7,000-$10,000 with the Chevy Silverado. Unfortunately, right before the Detroit Show, the company was forced to recall 300,000 vehicles overshadowing its truck of the year victory. Concurrently, Ford is launching an all-aluminum F-150 that will cut 700lbs from the body weight, which makes the truck far more fuel efficient than competitors with 25 mpg. GM is unlikely to have an all-aluminum truck on the market for 3-5 years.
Thanks to innovation, Ford is poised to maintain its dominance in trucks. While GM's new CEO is very well-regarded, Alan Mulally has an unmatched track record that ensures Ford will continue to be the best run auto company in the country. After Mulally ushers in this major product refresh, Ford will be poised for several years of robust growth while GM will be playing catchup. Now, GM does have a lead in emerging markets like China where it outsells Ford three to one, but Ford is making strides in these markets with sales up 50% in China. Emerging markets will be major growth markets for both companies for several years. GM will benefit upfront thanks to a stronger sales base, but Ford's significant investment in capacity will lead to strong growth rates.
With this dividend hike, all of the good news in the GM story is baked into the stock, and it basically trades at the same multiple as Ford even though Ford is better positioned in Europe, has innovative products set to launch, and is gaining ground in emerging markets. At 9x earnings, GM is certainly not an unwise investment, but Europe will continue to weigh on results, capping upside potential. I am looking for shares to rise about 10-15% in 2014 while I expect Ford to rally 20-25% on the back of strong product launches that will lead to a record 2015. The market has misunderstood Ford's profit warning as bad news when it was more of a calendar issue. As a consequence, investors should sell GM where investors are already exuberant and move into Ford, which has better upside over a 1-5 year time frame.