Most investors read the headlines, watch the momentum, and then draw a conclusion as to the value and risk of their investments. This at times causes the investor to miss the bigger picture. Today, we witness a perfect example of that dynamic with General Motors (GM) and the weak situation in Europe and/or their (in)famous Volt.
As we discussed in previous articles, GM is clearly a value investment as most metrics point to improved operating efficiency and future upside potential. What distracts investors currently though is their widely publicized European shortcomings along with the weakness surrounding Volt. Perspective gets tossed out of the equation at times, so let's first start by looking at the facts.
Volt: Battered Image, But Less Than 1/10 of 1% Of Sales
When evaluating a potential failure of the Volt platform and the potential impact to General Motors overall, one must take into account the relative size of the line. Volt sold less than 8000 cars in its debut year (2011), and that compares to over 9 million for every other line that GM produces. The negative publicity surrounding the Volt has weakened GM's image and obscured the financial and operational progress that the company has made. Further, the high profile Volt detractors use any opportunity to highlight that GM is a product of bailouts (which makes great politics, but irrelevant for investing guidance). The fact is that the Volt is, if anything, a positive for the company. While its current contribution is completely infinitesimal, the technology and leadership could yield major benefits down the road.
Europe: Weak But Under Control
Yes, the European economy is weak and the number of cars sold is declining. And that weakness is affecting all the major volume producers from GM and Ford (F) to Fiat (OTC:FIATY), Toyota (TM), and Peugeot (OTC:PEUGY). In fact, the car companies themselves estimate that excess industry capacity is as much as 20%. While it will be a few years before the industry hits its floor, the impact on the bottom line should be viewed in the proper context.
In GM's case, they previously took actions that cut their European 2011 loss by more than half to $0.7B from $2B in 2010. While their initial expectation was to be at break-even by now, they could lose up to another billion in 2012 and 2013 (assuming that they can not accelerate plant closings or labor adjustments in the interim). So what? Yes a billion dollars for the next couple of years is important, but consider that in 2011 alone the company made a NET PROFIT of $7.6 Billion. That is $7.6B including a $0.7B loss in Europe.
US: #1 economy in world (GM #1)
GM has seriously reduced its US break-even levels to 11 million of industry SAAR, and they improved their balance sheet with minimal debt and over $30B in cash. The US auto industry has years of pent-up demand ahead, as below trend production levels have now extended into their 4th year. The average age of a US car is 11-years, and people must replace cars that wear out. The US car market was passed by China in terms of total volume, but in terms of profitability is still unmatched. As GM is the largest US producer, they should remain very profitable and expand on 2011 earnings of $7B.
China: #2 economy in world (GM #1)
GM has partnerships with several companies in China that give them up to 50% ownership in their joint ventures. Through these partnerships, GM produces more cars in China than any other car maker. While the Chinese car market slowed over the past year, two facts should still be clearly understood: 1) China has passed the United States as the largest car market in the world and 2) the potential for future growth is still enormous as the penetration rate is still well below western standards.
While the stock price of GM has rebounded somewhat in 2012, there is still much room to go forward. The fundamentals in place at the time of the $33 IPO (just over a year ago) remain true today, and in fact, have been somewhat proven by positive operating results in a relatively challenged environment. The noise from the media regarding Volt and European woes, should be viewed in context to their overall significance to the company's valuation metrics. We believe that at $25.39 per share or a $40B valuation, GM still offers potential to more than double over the next 3 to 5 years.