- Estimated intrinsic value for GM is mid-$50s.
- Estimated intrinsic value for F is low $20s.
- Both are trading at discounts to intrinsic value, with GM at a bigger discount.
In the battle between Ford (NYSE:F) and General Motors (NYSE:GM), we've long been fans of Ford Motor and Alan Mullaly, and have been long the shares since the high-single digits, low-double digits in both 2010 and 2012.
However, for the first time ever, we bought General Motors common stock in the 2nd quarter of 2014, starting near $37 in May '14, and have been slowly buying as the stock has come into the low $30s during the July correction.
Here is a quick recap of our bullish case on Ford:
1.) Assuming Ford can generate $2 to $2.50 per share, Ford's intrinsic value estimate is between $22-$25 per share. Once the stock trades into the low $20s, it becomes a nervous long position for us.
2.) Ford's North American pre-tax auto margin is at a record, above the 2007 peak of 7.5%-8%. Today, the NorthAm pre-tax margin is 11.5% as of Q2 '14, which was somewhat of a surprise given the negative downward guidance shocker last December '13 due to 2014 "launch costs".
3.) Europe was profitable on a pre-tax income basis in Q2 '14, another surprise, since the 2014 guidance I thought was for a negative year in the red in Europe. Europe lost $1.6 billion in 2013, versus the $2 billion guidance.
4.) Ford's cash flow is improving dramatically. Q2 '14 free cash flow on a 4-quarter trailing basis for the automotive division was $2.2 billion, which is financing all of the dividend and the small share buybacks currently.
5.) Ford is currently trading at 12(x) EPS, although F's EPS are expected to fall 18% from 2013's, given the launch costs. However using Thomson Reuters' Consensus EPS for '14, '15 and '16, Ford is expected to average 13% EPS growth over the next three years, with a lower multiple on the stock than the growth rate.
What do I worry about with Ford? The unions, bad management, poor decisions, the willingness and ability to produce a low-quality auto, operating leverage, the consumer, etc. etc.
So why buy GM now? The May '14 purchase of GM's equity for client accounts was our first ever of the other major American auto OEM.
1.) A $34.50 per share GM is trading at just 4(x) cash flow versus F's 8(x) cash flow. Neither metric is very pricey, but GM at 4(x) cash flow seems quite compelling.
2.) GM is trading at 14(x) expected 2014 EPS, with the average EPS growth rate over the next three years (per Thomson Reuters) of 14% on 3% average revenue growth.
3.) For GM, peak earnings are thought to be in the $5 area, with intrinsic value estimates for GM roughly putting fair value between $53-$58 per share, which means at $34.50, GM is trading at a 35% discount to intrinsic value versus Ford's 27% (assuming a midpoint of the two models).
Comparison of Ford vs. GM Valuation Metrics
|'14 EPS est.||$1.33||$2.73|
|'15 EPS est.||$1.92||$4.56|
|'16 EPS est.||$2.18||$4.93|
|3-year avg. exp. EPS growth rate||13%||14%|
|Price-to-free cash flow||28(x)||12(x)|
|3-year avg. exp. rev. growth rate||3%||3%|
|Debt as % of total capital||55%||14%|
|TAM's internal intrinsic value est.||$23||$52|
|Morningstar's intrinsic value est.||$25||$53|
|Current mkt. price 8/27/14||$17.35||$34.65|
|Discount to TAM's internal model||25%||34%|
|Discount to Morningstar's intrinsic value||30%||35%|
Source: Internal spreadsheet from Qs and earnings reports
exp. - expected consensus estimates
TAM - Trinity Asset Management
Frankly, after writing the article, I think both stocks could be bought today for a nice gain over the next few years, but you would need to hold the stocks through early 2016.
Note the EPS increases in 2015 for both companies.
The other "intangible factor" with GM is that I liked how Mary Barra handled all the negative press in May '14 and the Congressional testimony. The fact is Mary Barra has a rare opportunity to clear the decks at GM and set the company on a new course.
I do also think that after 2008 and the VEBA trusts, both OEMs got to jettison healthcare costs of the union, which should/could improve operating leverage and leave the companies more viable going forward, with the ability to generate better margins.
Finally, the average US car on the road today is supposedly 9 years old. That statistic, while greatly oversimplifying things, just screams opportunity for Ford and GM over the next few years.
I've always bought foreign personally. I will actually look at a US car the next time one is bought. I do think Ford and GM are making a better quality car today.
We'd buy a pullback to $14-$15 for Ford, and continue to buy GM as it trades lower into the low $30s.
While we have been long Ford for 3-4 years now, we think that both stocks are at least an 18-24 month holding period for investors.
Disclosure: The author is long GM, F. The author wrote this article themselves, and it expresses their own opinions. The author is not receiving compensation for it (other than from Seeking Alpha). The author has no business relationship with any company whose stock is mentioned in this article.