General Motors - If You Believe Analysts, This Stock Is Significantly Undervalued

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Includes: GM
by: Stock Market Sherpa

Summary

General Motors trades at less than 7.5 times forward earnings, according to analyst projects.

These analysts also predict impressive long term earnings growth for the company (nearly 15% per year).

Although General Motors pays an attractive dividend, the firm's margins and efficiency ratios demonstrate a poor competitive position.

Despite performing poorly in nearly every aspect of the DRAG framework, General Motors shares are undervalued by 50% if you believe analyst's earnings estimates.

Analyzing the investment merits of General Motors (NYSE:GM) is not a straightforward endeavor. The restructuring and subsequent bailout that occurred during the financial crisis make it nearly impossible to compare this current incarnation of General Motors to the previous company. Yet, despite all of this baggage, analysts predict that the company will earn $4.33 per share next year, meaning that its shares trade at less than 7.5 times forward earnings. In addition, the stock pays a dividend of nearly 4%. This article investigates General Motors from a fundamental perspective to determine whether it deserves a higher forward earnings multiple, therefore making the shares an attractive opportunity for individual investors.

Please click here to read my article which outlines the DRAG analysis framework in more detail.

To summarize, the four variables used in a DRAG (dividend and risk adjusted growth) analysis are as follows (each company is ranked from 0 to 3 in each category):
1) How cyclical is the industry in which General Motors operates?
2) How strong is General Motors' competitive position within this industry?
3) How risky is General Motors' balance sheet?
4) What is General Motors' dividend yield and dividend growth history?

The premise is that a company that operates in a non-cyclical industry, with a strong competitive position and a clean balance sheet that pays an attractive dividend should trade at a higher earnings multiple than a company without these attributes, even if the lower quality company has higher projected future earnings growth. After adjusting for these variables, it becomes easier to compare companies in different sectors with different levels of future growth potential.

General Motors DRAG Analysis:

General Motors Industry Analysis

Industry Beta

1.28

Stock Beta

1.13

5 Year EPS Std Dev

140.4%

Industry Score

0/3

The automotive industry has certainly staged an impressive rebound in recent years. However, requiring a government bailout is not something that often happens to large companies in stable industries. General Motors has been consistently profitable since 2012, despite the ongoing recall issues. Not surprisingly, the company's shares have exhibited above average volatility during the last year and this academic website shows that share prices of automobile manufacturers tend to be 28% more volatile than the broader market. The history of this company itself and the American automotive industry as a whole illustrates its highly cyclical and economically sensitive nature and this uncertainty is likely one of the main reasons that GM shares currently trade at such a discounted valuation.

General Motors Competitive Position Analysis

Gross Margin

8.7%

Operating Margin

0.3%

Return on Assets

1.5%

Return on Invested Capital

4.3%

Competitive Position Score

0/3

Although the aforementioned recalls have negatively impacted these figures in recent quarters, General Motors remains an inefficient firm. And while Ford's (NYSE:F) margins are slightly wider, the automotive sector as a whole tends to operate with narrow margins and low returns on invested capital. Given the series of hits that General Motors has taken to its reputation, it would be nearly impossible to argue that the firm enjoys any sort of competitive advantage over other automobile manufacturers - either in America or internationally. If the company begins to show improvement in terms of return on assets or invested capital, its score in this section of the analysis would likely be raised to reflect it. However, in the current environment, General Motors faces a particularly challenging competitive situation.

General Motors Balance Sheet Analysis

Debt to Equity Ratio

0.69

Current Ratio

1.29

Interest Coverage

8.6

Balance Sheet Score

1/3

Although the government bailout helped General Motors significantly improve its balance sheet, the current company still does not possess the level of financial flexibility investors might desire given the economic sensitivity of the automobile industry. The company has nearly $30 billion in cash and short term investments on hand, which offsets much of its total debt outstanding ($40 billion). However, the firm also accounts for more than $18 billion in pension liabilities and neither its current ratio nor level of interest coverage should inspire a meaningful level of confidence amongst shareholders.

General Motors Dividend Analysis

Current Yield

3.8%

Payout Ratio

58.2%

1 Year Dividend Growth

N/A

3 Year Dividend Growth

N/A

Dividend Score

2/3

Earlier this year, General Motors initiated a quarterly dividend of $0.30 per share, which represents a yield of close to 4%. While the company obviously does not have the type of long term track record that most income investors are seeking, its dividend is certainly a bonus for shareholders and appears sustainable (at least in the short term) given the firm's projected net earnings growth and solid free cash flow generation. Of course, any sort of meaningful slowdown in global demand for automobiles could raise questions about the sustainability of these quarterly payouts, so investors should enjoy them, but not count on them to provide income over the long term.

General Motors DRAG Analysis

Total DRAG Score

3

/4 = Average DRAG Score

0.75

x Projected LT EPS Growth Rate

14.81%

x Projected 2015 EPS

$4.33

= General Motors Target Price

$48.10

Despite all of these negative attributes, this model still suggests that General Motors' stock price is undervalued by 50%. Analysts anticipate that the firm will generate impressive earnings growth over the coming years and the stock's current valuation is absurdly low. Its forward PEG (price to growth ratio) is exactly 0.50. And while the DRAG framework punishes General Motors for the cyclical nature of its business, poor competitive position and merely adequate balance sheet, it remains nearly impossible to view a stock trading at less than 8 times forward earnings as overvalued. When you add in General Motors' above average dividend, it becomes clear that for investors who can tolerate significant risk and volatility, this stock will likely produce massive gains for its shareholders, provided it can achieve the results that analysts predict.

Disclosure: The author has no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

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.