General Motors Company (GM) emerged from bankruptcy in 2009 as a much leaner company than the 'old GM'. The number of brands sold in the US was cut down to only four: Chevrolet, Cadillac, Buick, and GMC. As a result of the government bailout of GM, the US Treasury owns about one-third of the company. General Motors is the market leader in the US with a 19% market share, besting rival Ford Motor Company (F).
GM's initial public offering occurred in November of 2010, with a initial price of $33 per share. Since then the stock has dropped considerably, currently trading at $19.91 per share. Here are the financial results for the past two years.
| (In Million $) | 2010 | 2011 |
|---|---|---|
| Revenue | $135,592 | $150,276 |
| Operating Cash Flow | $6,780 | $8,166 |
| Capital Expenditure | $-4,211 | $-7,078 |
| Free Cash Flow | $2,569 | $1,088 |
Revenue increased by nearly 11%, but a sharp increase in capital expenditure led to a lower free cash flow. Capital expenditures are expected to be around $8 billion in 2012.
Owner Earnings
Owner Earnings are a better measure for valuation purposes than free cash flow. Warren Buffett defines Owner Earnings as follows:
These represent (1) reported earnings plus (2) depreciation, depletion, amortization, and certain other non-cash charges... less (3) the average annual amount of capitalized expenditures for plant and equipment, etc. that the business requires to fully maintain its long-term competitive position and its unit volume... Our owner-earnings equation does not yield the deceptively precise figures provided by GAAP, since (3) must be a guess - and one sometimes very difficult to make. Despite this problem, we consider the owner earnings figure, not the GAAP figure, to be the relevant item for valuation purposes.
I'll calculate Owner earnings by taking the Net Income and adding back various non-cash items, such as depreciation, and then subtracting the expected Capital Expenditures. I'll also add interest payments adjusted for taxes since interest is tax deductible.
| (In Million $) | 2010 | 2011 |
|---|---|---|
| Net income | $6,503 | $9,287 |
| Depreciation & amortization | $6,923 | $7,344 |
| Amortization of debt discount/premium and issuance costs | $163 | $200 |
| Other non-cash items | $-6,070 | $-4,457 |
| Interest Payments | $1,098 | $540 |
| Avg Capital Expenditure | $-8,000 | $-8,000 |
| Owner Earnings | $617 | $4,904 |
Owner earnings smooth out capital expenditures and provide a clearer picture of the profitability of the company. Let's use the Owner Earnings figures to determine General Motor's Cash Return on Invested Capital, or CROIC. This is the cash return generated by the company on invested capital, and is simply the Owner Earnings divided by the total invested capital. This is a better measure than ROIC because ROIC relies on earnings, which is a poor measure of profitability.
| (In Million $) | 2010 | 2011 |
|---|---|---|
| Owner Earnings | $617 | $4,904 |
| Invested Capital | $138,898 | $144,603 |
| CROIC | 0.44% | 3.39% |
GM's CROIC is not particularly high at just under 3.4%, but it has grown substantially from 0.44% in 2010. As the new company is still only a few years old, it's difficult to project the efficiency going forward. Let's take a look at the most recent balance sheet.
| Cash and Cash Equivalents | $32,064 |
|---|---|
| Investments | $6,793 |
| Debt | $14,224 |
| Pension Obligations | $31,849 |
| Minority Interest | $884 |
| Net Cash (Debt) | $-8,100 |
| Diluted Float | 1,682 |
| Cash/Share | $-4.82 |
GM has about $39 billion in cash and investments and $14 billion in debt. The big drag on the balance sheet, however, is the $32 billion in pension obligations. This leads to $4.82 in net debt per share. The large pile of cash on the books is definitely a plus, but the pension obligations are certainly a concern.
Valuation
I use a discounted cash flow analysis to estimate the fair value of a company. I will use a discount rate of both 12% and 15% and use these values to define a fair value range. I will assume that owner earnings will grow by 6% next year and I will allow that growth rate to decay over 20 years to a perpetual growth rate of 3%, as per the growth table below.
| Year | 1 | 2 | 3 | 4 | 5 | 6 | 7 | 8 | 9 | 10 |
|---|---|---|---|---|---|---|---|---|---|---|
| % | 6% | 5.85% | 5.7% | 5.55% | 5.4% | 5.25% | 5.1% | 4.95% | 4.8% | 4.65% |
| Year | 11 | 12 | 13 | 14 | 15 | 16 | 17 | 18 | 19 | 20 |
| % | 4.5% | 4.35% | 4.2% | 4.05% | 3.9% | 3.75% | 3.6% | 3.45% | 3.3% | 3.15% |
For reference, the average analyst estimate for 5-year earnings growth is 14.13%. Using the above parameters, I arrive at a fair value range of $25.00-$35.79.
Conclusion
General Motors is currently trading at a 20% discount to the lower bound of my fair value range. I think anything below $20 a share is a steal. I opened a long position in GM in October 2011 and added to it in December 2011 at an average price of $20.79 per share. I then closed this position in March of this year at $26.38 per share when I had determined that the stock had become fairly valued.
I will be looking to open a new position within the next few months if the price remains depressed. I think that $20 a share is bargain and that General Motors offers exceptional value at current prices.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: I will be looking to open a long position in GM within the next three months.
