I own a Japanese car but started researching General Motors (NYSE:GM) after some of the prominent value investors, including Berkshire Hathaway (NYSE:BRK.A) (NYSE:BRK.B), started buying the company. It seems GM is hated by the investor community due to some of the risks surrounding the company. Any investors' goal should be to worry about the downside risks of an investment, since the upside will take care of itself. I will thus focus the majority of this article discussing the downside risks of General Motors and briefly discuss the catalysts that may propel the stock upward.
- Uncertainty around whether General Motors can retain its bankruptcy shield: While a Federal judge ruled in 2015 that GM can retain the bankruptcy shield that protects it from as much as $10 billion in claims brought by customers seeking damages tied to faulty ignition switches, the decision has been appealed and is currently in the Appeals court. While I'm not a lawyer, it seems increasingly unlikely that GM will be liable for the entire $10 billion in damages and at best will be liable for a portion of the damages. Even in the worst-case scenario - which is extremely unlikely - General Motors maintains a cash balance of $20 billion.
- Uncertainty around settlements of cases related to defective ignition switches: To help resolve the multi district litigation cases involving ignition switches , the plaintiffs and GM had each picked three bellwether cases (total of 6 cases). Four of the six cases (registration required) have been resolved so far and the remaining two are expected to be resolved by the end of the year. The major takeaway here is that GM is on track to resolving these cases latest by Q1 of 2017
- Risk that US auto sales have peaked and will slide down: Despite record auto sales in the past few years, the average age of a typical car on the road was a record high of 11.5 years as of July 2015. Sure, vehicles are lasting longer due to improvements in quality. There is no indication, however, that the industry tailwind has subsided. Experts forecast that the car sales will average 17M-18M per year over the next 5 years. Furthermore, even in the rare event that the US experiences a recession, GM has changed its business model where it claims it can break even if US car sales dropped to 11 million per year (which is close to 2009 levels)
- Slowdown in China: Around 20% of GM's profits is expected to come from China and there's been a concern raised that the slowdown in China may impact GM's earnings. It's important to point out that sales in China is still expected to grow, but not at a rate achieved in the past.
In summary, there is a lot of uncertainty around the outlook for GM, and investors hate uncertainty. If you take a close look at every risk that GM is facing, the risks are either clearly overblown or are expected to be resolved within the next year or so. On the contrary, management has shown courage in focusing on return on invested capital and margins - and therefore profitability - rather than sales evidenced by their decision to trim down fleet car sales. Furthermore, GM is also going to benefit from its vehicle launch cadence from 2016-2019.
On the speculative side, the following outcomes may help support GM's stock over the long term, although they are not crucial to my investment thesis
- Manufacturing in the US increases due to low energy prices.
- Management is able to achieve satisfactory returns on capital with their investment in car sharing, autonomous driving, and electric cars.
- Growth in GM financial and Onstar.
The auto industry is extremely competitive, and this is not a stock I would hold onto indefinitely. This is an industry where the auto manufacturers have no moat. During my recent trip to Dallas, Texas, however, my perspective changed a bit. Every other household owned an American truck. No wonder, American auto manufacturers have leading market shares in the light trucks category. This seems to indicate that GM (and other American manufacturers) exhibits some moat in this category. It's good to know that GM makes most of its profits from sales of trucks and SUVs.
GM's reputation has also not been helped by the fact that Japanese cars have been thought to be more reliable than their American counterparts. That may have been true in the past, however, GM these days makes much better cars that they did 10 years ago. Furthermore, although I expect Ford (NYSE:F) and Fiat Chrysler (NYSE:FCAU) to do reasonably well over the next 2-3 years, I expect GM to do even better.
After weighing the industry tailwinds, management's decisions, and the risks facing the company, I would recommend that investors add GM to their portfolio.
Disclosure: I am/we are long GM, GM CLASS B WARRANTS, GM JAN 2018 CALL OPTIONS.
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.