Description

Thesis:

GM is down close to 50% over the last 12 months and at the current valuation presents a great way to invest in the recovery and restructuring of the US auto sector. We think it could be a double – with limited downside risk and a net cash balance sheet – that is producing significant amounts of free cash flow currently. We believe this opportunity exists due to recent macro fears about a double dip, negative investor perception of the GM prior to bankruptcy that has kept investors from studying the restructured business, and overhang from the 25% US Gov ownership.

GM’s profitability is principally tied to its North American operations, where it produces cars under the Buick, Cadillac, Chevy and GMC brands. It has operations around the world under these brands (and others), including in Europe, where it has been losing a comparably smaller amount in recent quarters. GM also has stakes in profitable, long-established China-based JVs, which benefit from the enormous success of the Buick brand in China.

Valuation:

GM currently trades at $22. Stripping out $6 in NOLs and $1 in excess cash today (see balance sheet section below), you are left with $15, roughly 3x our ’13 after-tax EPS estimate of ~$4.70 (this includes $1 from China JVs). We think GM offers close to a double in a reasonable base case without gargantuan assumptions in auto volume recovery, but it could be more than a double if a full auto recovery takes hold.  Auto volumes have been depressed for some time.  If a double dip occurs and auto volumes revert back to 2009 levels, we think downside is limited to 25%.  GM is extremely cheap on an absolute basis, and on a relative basis to its peers. 

Improved GM:

Today, GM is a much better company than it was prior to bankruptcy and we think this fact is lost on the market.  The management team is stronger, consisting of former banking and private equity individuals who we expect to be disciplined with capital allocation and cash generation.  Significant UAW wage concessions have been granted, from $80 hourly pre-bankruptcy to $56 post, allowing it to compete more favorably with foreign competitors, even at depressed SAAR levels.  Vehicle refresh rates have improved, which has historically led to share gains.  GM has the best balance sheet amongst the US operators and a manageable pension obligation.  In addition, GM has a valuable JV in China that we think deserves a premium multiple.  One could argue the China operations should be valued at 10x or higher on its $1 EPS, which would create the non-China GM stub very cheaply.

Assumptions:

What does one has to assume to be a believer in the investment and create a potential double?  Our EPS estimates above are based on SAAR of 13mm & 13.5mm for ‘12 &13’ versus 12.8 in 2011 (December 11' SAAR came in at 13.6mm (it is an anualized figure)).  We think GM can remain profitable even at sub 2009 SAAR levels of 10m as a result of their cost structure improvements, which shields downside making this a lower risk play on auto recovery.  While it’s hard to pin-point what SAAR will be in any given year, we think it is fairly conservative to assume 12.5m normalized SAAR from replacement demand (250m cars & 5% annual scrap rate) and with population growth to maintain ownership rates you can get to 15m, and would imply more than a double in the stock.  For historic perspective, SAAR was 11.6m in 2010, 10.4m in 2009 and 16m pre-2008.  Although, one does not have to assume this for the thesis to work, there is an opportunity to regain market share as GM improves its designs and vehicle refresh rates. 

Balance Sheet:

GM has ~$30Bn in cash on the balance sheet. $4Bn of auto debt, $5.5Bn series A preferred, and $1Bn minority interest take net cash per share to $12 currently (we treat the Series B pref as if-converted) prior to the pension liability.  We’re waiting for the disclosure on year end funded status of the pension obligation, but believe it will shake out around $20B under-funded after tax, leaving you with roughly $1 of true net cash per share.  GM is generating significant amounts of FCF, so this balance is growing rapidly. 

The pension obligation is obviously a concern here, but we feel that GM’s massive cash cushion gives some comfort.

Disclosure:

We and our affiliates are long General Motors (GM) and may long additional shares or sell some or all of our shares, at any time.  We have no obligation to inform anybody of any changes in our views of GM. This is not a recommendation to buy or sell shares.  Our research should not be taken for certainty.  Please conduct your own research and reach your own conclusion

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