General Motors (GM) shares were hammered despite posting better-than-expected earnings of $1.03 per share (compared with analyst estimates of approximately 95 cents per share) on Wednesday morning. The drop in share price can largely be attributed to GM's disappointing Q4 guidance (pdf) and weakness in Europe. While shares had topped $26 in the last week of October, GM dropped nearly 11% on Wednesday to close at $22.31 (Source: Yahoo Finance). Is it time to sell, or has the latest drop in GM's share price created a good buying opportunity?
GM has benefited over the past year from new products, particularly the highly successful Chevrolet Cruze compact. The company recently introduced a new sub-compact, the Chevrolet Sonic, which has garnered fairly positive reviews. It has also gained market share, particularly in the U.S., as a result of Japanese automakers' woes in light of the March tsunami and the strong yen. The chart on page 12 of the GM slide deck (pdf) shows how incentive spending plunged beginning in March, resulting in a better bottom line.
However, ongoing economic weakness in Europe has made it impossible for GM to break even in that region. As a result, GM forecasted EBIT (earnings before interest and taxes) similar to Q4 2010, which implies $1.0 billion (pdf). This is a significant decline from $2.2 billion in EBIT for Q3.
I don't quite believe it, though. Clearly, between seasonal trends and weakness in Europe, GM will have a soft Q4. But I think that management is overcompensating by trying to dampen expectations. Once again, Honda (HMC) and Toyota (TM) are encountering problems, and this should allow GM to maintain or even increase its U.S. market share while keeping incentive spending well below last year's levels.
Massive flooding in Thailand has caused parts shortages, which have forced Honda to cut North American production to 50-75% of plan since the beginning of last week. This may continue until next month, resulting in shortages at Honda dealerships. Lower inventory levels generally lead to lower incentive spending, which will benefit Honda's competitors, including GM. While Toyota has not been hit quite as badly this time, it has been compelled to scale back its attempts to recoup lost production from the spring. Meanwhile, Toyota is currently coping with a large recall of 550,000 vehicles. While the problems don't appear that serious, this incident may further dampen customer loyalty at Toyota. GM could be a major beneficiary due to its competitive new offerings.
On a valuation basis, GM seems extremely cheap at current prices. Even if the disappointing Q4 forecast is borne out, GM will still bring in nearly $4 in EPS, making for a P/E ratio below 6. Moreover, GM has a very strong balance sheet; its $33 billion in automotive cash sits only marginally below GM's total market cap, and the company's unfunded pension status improved last quarter. While a severe slowdown in the global economy could lead GM's earnings to plunge next year, the more likely scenario is another year of slow growth. This should allow GM to equal or improve slightly upon this year's results in FY12. Over the long haul, as vehicle sales rates move closer to the historical averages and as GM simplifies its global production by building multiple cars on the same platform, we can expect significant upside to GM's earnings.
In summary, while GM may have a rough ride in the near term, things are not likely to be as bad as management suggested in its Q4 forecast. In the long run, lower costs and higher sales could drive substantial EPS growth. At present levels, the stock seems like a buy, though I would recommend scaling into a position as there could be some further downside in the next few weeks if the European debt crisis continues to create negative headlines. But if the price were to drop below $20 again, GM would be a steal.