Description

Executive Summary

General Motors ("GM," the "Company," or "New GM") is a leading global automotive manufacturer with operations in over 120 countries.  Including joint ventures in China, the Company sold 8.2 million vehicles over the past twelve months ending 9/30/10 which represents 11.5% of total vehicle sales worldwide.  North America accounted for 32% of sales, Europe accounted for 20%, and the rest of world accounted for 48%.  Of note, GM has the largest market share of all the global OEMs in the fast growing BRIC countries (Brazil, Russia, India, and China).

The New GM is a much better quality company than the Old GM.  Through the bankruptcy, GM eliminated the majority of its debt (the Company now has net cash and plans to repay outstanding debt over the next 2-3 years) and cut a substantial amount of cost from its business.  For example, in North America GM eliminated approximately $9 billion from its $84 billion cost structure (11% of total) and now breaks even at the bottom of the cycle (10.5-11.0 million SAAR) instead of the middle of the cycle (15.0 million SAAR).  The industry is also much healthier.  During the recession, OEMs around the world reduced capacity significantly which led to improved pricing and more rational competition.

GM is cheap on an absolute basis.  At $36.50, the Company trades at 4.5x 2012 EBIT, 2.7x 2012 EBITDA, and 5.9x 2012 earnings assuming the Chinese JVs trade at a relatively inexpensive 10x earnings.  These multiples are cheap given GM's improved quality and strong cyclical and secular growth prospects.  On the cyclical side, both U.S. and European vehicle SAAR are currently well below replacement demand at 12 and 18 million, respectively, and should rebound to 14 and 20+ million by the end of 2012 as the respective economies continue to recover.  On the secular side, auto penetration in the BRIC countries is still well below the developed markets and should increase as these countries grow wealthier.  Given GM's #1 market share in these countries, it is best positioned to benefit from this secular growth dynamic.

On a relative basis, GM is also cheap.  Ford, its closest peer, trades at 4.7x 2012 EBITDA and 8.2x 2012 earnings.  Assuming GM trades at 4.5x 2012 EBITDA, which is a slight discount to Ford, there is 45% upside from a limit of $36.50.  This seems reasonable given GM's better growth prospects in the BRIC markets.

In summary, GM is an improved company in an improved industry with strong cyclical and secular growth prospects.  This, combined with its cheap valuation, make GM a compelling investment.  Furthermore, downside is limited given you are buying GM at the bottom of the cycle with significant pent-up demand, especially in North America.

Investment Thesis

• Cheap valuation.  At $36.50, GM trades at 4.8x 2012 EBIT, 3.1x 2012 EBITDA, 5.3x 2012 earnings, and 0.39x 2012 revenue.  If you back out the Chinese JVs at 10x net income, the multiples fall to 4.5x 2012 EBIT and 2.7x 2012 EBITDA.  A 10x earnings multiple for the JVs is arguably conservative given that the comparable publicly traded Chinese companies trade in the mid-teens.  At this valuation, GM is cheap on an absolute basis given its solid growth prospects driven by the cyclical recovery in North America and Europe and the secular growth opportunity in the BRIC markets, where it is the market share leader.  On a relative basis, GM trades at a significant discount to Ford (4.7x 2012 EBITDA, 8.2x 2012 earnings, 0.49x 2012 revenue), its closest peer, even though its growth prospects are better.  In my view, GM's relative value gap vs. Ford will close as it continues to execute and the overhang from bankruptcy lifts.  In addition to being cheap on a relative basis, GM is in an industry where there is an opportunity for a multiple re-rating.  Overall, the industry trades at similar multiples as it did in the past despite increased stability of earnings due to capacity reductions and cost cuts, and a lower risk profile due to less levered balance sheets and increased revenue diversification.  Due to these improvements, the companies are earning similar profits at the bottom of the cycle as they did at the top of the last cycle.  For example, GM will earn approximately $15 billion of EBITDA in 2010, which is 10% higher than 2007, despite U.S. and European vehicle SAAR being 29% and 20% lower, respectively.  As SAAR continues to recover, there will be a significant opportunity for growth that I believe is underappreciated by investors which should lead to further multiple expansion.

• Strong cyclical growth prospects.  Current demand in North America and Europe is well below replacement.  As consumer sentiment improves, demand should continue to rebound back to the normalized level and may even overshoot due to pent-up demand that has built up over the last few years.

• Strong secular growth prospects in the BRIC markets.  At 13%, GM has the largest market share in the BRIC markets and is best positioned to benefit from the rapid growth as car penetration increases.  This compares to GM's closest peer Ford, which has a low single digit market share (1.9%).  CSM, the leading automotive market forecaster, projects that production in Asia (excl. Japan and Korea) and South America will be 49% and 36% higher in 2015, respectively, vs. 2010.  This increase will be driven by a rise in car penetration as the BRIC countries grow wealthier.  In my view, there is plenty of upside on top of CSM's forecast.  Sales in the BRIC markets would have to triple to reach the average sales per person in the non-BRIC markets (weighted avg. non-BRIC vehicles sold per 100 people = 2.8, weighted avg. BRIC vehicles sold per 100 people = 0.9).  In addition, the vehicle penetration in the non-BRIC markets is over 10x greater than the vehicle penetration in the BRIC countries (weighted avg. non-BRIC vehicles per person = 0.51, weighted avg. BRIC vehicles per person = 0.05).

• Improved cost structure.  During the bankruptcy, GM cut approximately $9 billion of cost from its North American cost structure causing its break-even to improve to 10.5-11.0 million U.S. SAAR from 15.5 million previously.  The largest component of GM's cost savings is labor - from 2007 to present, GM cut its North American labor cost by 55% from $11 billion in 2007 to $5 billion presently.  GM's labor savings were driven by a 36% reduction in its workforce and the elimination of its retiree healthcare obligation.  In addition to these labor cuts, GM reduced production capacity by 40% and its dealer network by 28%.  Outside of North America, cost has been more difficult to cut.  In Europe, GM is in the process of cutting capacity by 20% mainly through the closure of its Antwerp, Belgium plant.  As a result, GM hopes to break-even in Europe next year.

• Solid balance sheet.  Through the bankruptcy and IPO, GM was able to reduce its debt from over $50 billion to $11.1 billion comprised of $5.6 billion of debt and $5.5 billion of preferred stock (excludes mandatorily convertible preferred stock).  GM now has $14.2 billion of net cash, which is a stark contrast to the past decade when it ran its business with well over $10 billion of net debt on a regular basis.

• Improved pricing.  Global capacity reductions have led to improved pricing throughout the industry.  A main driver of the improved pricing has been lower incentives, especially for GM.  During the last three quarters, incentives for GM have fallen from over $4,000 per vehicle to approximately $3,000 per vehicle.  In addition to lower incentives, over the past 12-18 months, GM increased price by 11% which equates to an additional $8 billion of revenue.  This pricing power will likely grow stronger when GM refreshes approximately 56% of its fleet in 2012 and 2013 while the rest of the industry only refreshes 42%.  Note that fleet refreshes typically lead to increased pricing power and market share.

• GM will gain market share in the leasing segment of the auto market due to its recent acquisition of AmeriCredit.  Over the past 12-18 months, GM has lost share in the leasing segment of the auto market due to GMAC's increased focus on prime/non-lease lending.  In 3Q10, leases accounted for approximately 7% of GM's sales vs. the industry at 21%.  To address this market which the Company underserves, GM announced in July 2010 that it entered into a definitive agreement to acquire AmeriCredit for $3.5 billion.  In my view, this acquisition should allow GM to gain back its lost market share in the lease segment of the market over the next few quarters.

Investment Concerns

• Double dip recession.  During the 2008-2009 recession, U.S. and European vehicle SAAR fell below 10 million and 18 million units, respectively.  GMNA's current break-even is 10.5-11.0 million units and GME's break-even after the closure of its Antwerp, Belgium facility will be approximately 19 million units.  If these recession lows are tested again, both GMNA and GME will lose money.  However, unlike the prior recession, GM has a strong balance sheet with nearly $30 billion of liquidity including its $5 billion undrawn revolver.

• Higher oil prices cause the mix to deteriorate.  If oil prices rise, demand for trucks, which are less fuel efficient, will likely decline.  Nearly 65% of GM's production in North America are trucks.  Based on my estimates, the contribution margin of trucks are more than double that of cars.  For every 1% mix shift to cars, GM will lose $136 million of EBIT.  To take this risk into account, I assume the mix will deteriorate to less than 60% by 2012.  Note that the mix bottomed at 55% in 2008 when oil spiked to over $130 per barrel.

• Pension overhang.  GM's retirement obligations are underfunded by $32.8 billion.  Note that this includes the $2 billion of cash and $4 billion of stock that GM contributed to its U.S. pension as part of the IPO.  The $32.8 billion gap is comprised of $13.0 billion for the U.S. pension, $10.3 billion for the non-U.S. pension, $5.6 billion for the U.S. OPEB, and $3.8 billion for the non-U.S. OPEB.  GM plans to contribute over $10 billion to its U.S. pension over the next two years and I expect it will be fully funded by the end of 2012.  GM is not required, and has no plans, to fund the OPEB and non-U.S. pension liabilities.  To account for this large liability, I tax effected it at 35% and included it in the enterprise value as debt.

• China.  GM's large exposure to China provides the Company with a significant growth opportunity, but is also risky.  The largest China risk is the economy.  Many investors are concerned that it could be overheating and that there is a property bubble.  If this bubble bursts and wealth disappears, demand for autos will decline.  Another China risk is the joint venture structure that GM and other multi-nationals are forced to operate under.  GM's partners could potentially steal its proprietary technology and use it to compete and for their own profit.  In my view, this risk is lower for GM than the industry.  According to many analysts, GM's relationship with its largest partner, SAIC, is the strongest within the auto industry.  Moreover, SAIC recently bought $500 million of GM stock during the IPO to further strengthen its relationship with GM.  The last China risk is the government, which is unpredictable and could intervene to make operating in China far less attractive to GM.

• Poor product refresh.  As previously mentioned, GM is in the midst of refreshing its product line-up.  Typically this leads to market share gain and strong pricing power.  However, there is a chance that the new line-up fails to attract interest and leads to market share loss.  The management team is new and GM has not done a major refresh for several years.  Even with a lack of track record, I am optimistic based on management's comments to date.  For example, management has committed to spend $7 billion per year on capex (even during downturns) to maintain and build its brand value.  The Old GM was forced to cut capex to $5.5 billion during the downturn due to liquidity constraints, which delayed product refreshes and led to share loss.

• Ownership overhang.  Even after significant sales during the IPO, UST, the Canadian government, and the VEBA still collectively own nearly 50% of the shares outstanding.  These shareholders will likely be sellers over the next 1-2 years, which could be an overhang on the stock.

• Is the industry really different?  Over the past 12-18 months, significant production capacity was cut from the industry and balance sheets were solidified.  More importantly, pricing has improved which has led to much better profitability at the bottom of the cycle.  In summary, the evidence to date that the industry is healthier has been positive.  However, I think a healthy amount of skepticism is needed given the industry's past track record.  What will happen if we enter a double dip?  Will the OEMs get more aggressive with price to try to steal share to maintain volumes?  Unless we enter a double dip, we will not know the answer to this question.

Catalyst