Moody's is materially overstating the credit risk of General Motors Company (NYSE:GM) with its Ba1 rating. Our fundamental analysis highlights a much safer credit profile for GM: the company's strong cash flows cover all their obligations including debt maturities. Moreover, if their cash flows ever fall short of their obligations, the combination of their cash flows and sizable cash on hand should allow them to service any shortfall. Furthermore, their sizable market capitalization and strong recovery rate should allow them access to credit markets if they choose to refinance their debt. We therefore rate GM six notches higher at an IG3+ credit rating, or an A1 equivalent using Moody's ratings scale. (To register for free access to our corporate credit ratings, please click here.)
In addition, credit markets are overstating GM's credit risk with a CDS of 224bps and a cash bond YTW of 2.520%, relative to an Intrinsic CDS of 81bps and an Intrinsic YTW of 1.530%.
Cash Flow Profile
We produce a Credit Cash Flow Prime™ chart for General Motors Company, as we do for every company we evaluate. The chart provides a far more comprehensive view of credit fundamentals than traditional ratio-based analyses. It shows the cash flow generation and cash obligations related to the credit of the firm, adjusted for non-cash financial statement reporting distortions from GAAP. The blue line indicates the gross cash earnings (Valens' scrubbed cash flow number) expected to be generated based on consensus analyst estimates and Valens Credit's own in-house research team. The blue dots above that line include the cash available at that time while the blue triangles indicate that same amount plus any existing, available lines of credit.
The colored, stacked bars show the cash obligations of the firm in each year forecast. The most difficult obligations to avoid are at the bottom of each stack, such as interest expense. The obligations with more flexibility to defer year to year, such as pension contributions and maintenance capital expenditures, are at the top of the stacked bars. All of the calculations are adjusted for non-cash distortions that are inherent in GAAP accounting, including the highly problematic and often misused statement of cash flows.
If the company generates and has cash levels that are above their obligations, the risk of default is extremely low. Even if the cash generated yearly is close to the levels of the stacked bars, a company generally has the flexibility to defer payments of various kinds. For example, they can allow assets to age a little longer, or they can cut certain maintenance costs such as maintenance capex. While decisions such as those can create other business concerns, the issue in credit risk is simply this: Does the company have enough cash to service their credit obligations?
GM's cash flows would be able to service all obligations including debt maturities through 2022. Moreover, the combination of their cash flows and sizable cash on hand should allow them to service all obligations including debt maturities going forward. Furthermore, the company's significant asset backing drives a robust 123.4% recovery rate on unsecured debt despite the firm's unfavorable net working capital profile. Their robust recovery rate and sizable market capitalization should allow them to access credit markets to refinance if they so choose.
Like most people, senior executives and board members do what they are paid to do. This is why GM's Form DEF 14A is key to understanding this company's fundamentals, something that credit agencies seem to be missing. Our Incentives Dictate Behavior™ analysis focuses on GM's senior executive compensation and governance. This analysis is meant to help investors understand corporate governance, how aligned a management team may be with shareholder interests, and the potential consequences of a management compensation framework to the business.
GM's management compensation framework holds positive signals for debt holders. Their short-term compensation is based on adjusted EBIT, adjusted automotive FCF, global market share, and global quality. Meanwhile, their long-term compensation is based on ROIC and global market share.
This framework incentivizes them to improve all three value drivers, especially margins and asset utilization. Additionally, management is not incentivized to overleverage their balance sheet, further reducing credit risk. Overall, GM's management compensation framework should lead to higher cash flows available for servicing obligations.
We provide analyses of companies' statements on earnings calls, termed Earnings Call Forensics. This analysis is meant to help assess a management team's confidence in their conference calls when discussing certain areas of the business such as operations, stability, strategies, their ability to manage business risks, and especially, their liquidity and solvency.
In the case of GM, the analysis of their Q4 2015 earnings call highlighted mostly highly questionable markers from management. Management appears confident that their focus on cost and capital efficiencies should drive higher earnings and cash flows, and better insulate them against a potential downturn. On the other hand, management appears concerned about the sustainability of margin growth and gas price tailwinds driving SUV, truck, and cross-over sales. They also appear concerned about the potential of the Chevrolet Bolt EV, and their ability to drive further operational improvements going forward.
Ultimately, a company's credit risk (or lack thereof) is driven by cash available against cash obligations. GM's credit risk is being materially overstated by Moody's and overstated by credit markets. Given GM's strong cash flows relative to all obligations including debt maturities, healthy liquidity profile, and robust recovery rate, ratings are expected to improve and credit market spreads are expected to tighten once the company's fundamentals are recognized.
Our Chief Investment Strategist, Joel Litman, chairs the Valens Equities and Credit Research Committees, which are responsible for this article along with the lead analyst, Cheska Pablico. Professor Litman is regarded around the world for his expertise in forensic accounting and "forensic fundamental" analysis, particularly in corporate performance and valuation.
Disclosure: I am/we are short GM.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.
Additional disclosure: As of the date of this report, officers of Valens Research and Valens Credit are engaged and have beneficial interest in an investment management company, Kennebec River Capital, which has actively traded, and may trade, in the securities and/or derivatives of the securities of: General Motors Company (GM).