On July 10th last year I wrote a Seeking Alpha article entitled "General Motors' Stock Is Much Cheaper Than You Think", essentially arguing that I thought GM stock was a bargain opportunity for long-term value investors since it was trading roughly between 6-7x its 2014 deferred tax asset adjusted earnings. Unsurprisingly the article received quite a response and almost immediately a deluge of comments ranging from extremely informative to downright nasty started to flow in. It's clear to me now that people's opinions are sharply divided on the issue of the 2008 auto bailout, and that merely mentioning General Motors at a dinner party is a sure fire way of spicing up the evening (or ending it prematurely). However, in the field of investing I find heated debates full of opinions to be worth very little and so when it comes to analysing investment opportunities I try to take a step back and focus on the facts instead. This article is no exception.
Since my last article in the summer, General Motors has had some rather material and meaningful events that are worth reviewing step by step.
First off, GM will likely finish 2013 at the upper end of my previously estimated range of $2.90 to $3.30 EPS (earnings per share), perhaps as high as $3.40 per share. That's good news to me and my fellow long-term investors because it shows that my old estimates were indeed conservative, and conservatism is absolutely crucial in helping to avoid huge mistakes.
Secondly, GM announced a dividend of $1.20 per share, which is equal to a dividend yield of just above 3%. Again, this was much higher than my conservative expectations of $0.80 per share, and I welcome this juicy payout as it gives me the opportunity to reinvest into GM stock and warrants at attractively low prices to increase my stake in the company over time.
Thirdly, at the Detroit Motor Show GM lowered its forward guidance for 2014, implying next year's earnings of around $3.80-$4.00 per share according to my own and some of the sell-side analysts' estimates. This has clearly been a major short-term disappointment to some of the short-term investors, or speculators, who entered the stock in recent months. I suspect many of them were expecting earnings of $4.40+ per share for 2014. However, if you read my article from last summer you will see that my estimated range of EPS in 2014 was in fact $3.80 - $4.50, so this development, while at the lower end of the range, is still within my estimates.
Also, if we dig a little deeper into the company's 2014 forward guidance we quickly find that it's really not that disappointing at all.
To quote Dan Ammann, GM's president, "We're taking advantage of the strength in the U.S. and China to engage in other areas such as our international operations," He went on to say that "restructuring costs should drop off significantly in 2015".
To state it in plain English, the reason GM is earning less in 2014 than most had initially expected is because they are investing a substantial sum of money in the future profitability of the overseas businesses (ex-China). Both GM Europe and GM International (ex-China) require some one-off restructuring in 2014 in order to continue on a path of strong and stable earnings growth in 2015 and beyond. The emphasis here being firmly and crucially on 'one-off investments' as opposed to 'recurring costs'.
As a result, even when I conservatively try to estimate a 2015 EPS figure I end up with a number between $5.00 and $5.40 per share. This means there is a big gap up between 2014 and 2015 earnings, simply because those one-off items affect 2014 but won't affect 2015 and thus go away as soon as we wake up on 1/1/2015. Most sell-side analysts agree with these figures and are within this range with their own estimates, so I feel very comfortable around this level.
Now, similar to last summer, what this means is that at Friday's closing price of $38.60, GM stock is trading at just 10.16x to 9.65x this year's earnings and just 7.72x to 7.15x next year's earnings. This multiple may look cheap, but guess what, GM is even cheaper than that! This is because investors are still not giving the company's deferred tax asset (DTA) enough credit. This asset allows GM to pay significantly less tax than it deducts on its income statement, and thus the company's EPS figures are somewhat distorted to the downside when compared to actual net cash earnings.
I highlighted in last year's article that the deferred tax asset is worth cold hard cash and today it still has a net present value of around $8 per share (if discounted at 14%). This means that a stock price of $38.60 implies that General Motors the company is selling for $30.60, while the DTA is selling for its full value of ~$8 per share. Or, if you prefer, General Motors the company is selling for $38.60 per share, while the $8 per share deferred tax asset can be yours free of charge. Either way, GM is still heavily undervalued when compared to its fair value, and is really just trading between 8.05x and 7.65x this year's DTA adjusted cash earnings, and between 6.12x and 5.67x next year's DTA adjusted cash earnings.
I'm pretty sure that GM's valuation won't stay this low forever and that sooner or later investors will give the company's future growth and DTA the value they deserve. Long-term investors would do well to exploit this inefficiency while it lasts. The newly instated dividend gives current investors a chance to reinvest proceeds to increase their stake at incredibly low valuations. There really aren't many industry leaders with a growth story that sell for that low a multiple.