General Motors: A Hold Through The Cycle – General Motors Company (NYSE:GM)

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Through most of this year, General Motors (GM) shares have been trading neutral. Over the past 3 years, the stock has meandered up and down, though it’s managed an 18% gain through the period. YTD 2019, GM shares are up ~10%.

General Motors Chart – Three-year weekly price / volume

Courtesy of BigCharts

Meanwhile, the current dividend yield is over 4%. The payout appears safe.

While I’m not advocating investors load up on shares today, I remain constructive on the company and the stock. I plan to hold my position through the cycle on the expectation that this automaker will do well during the next early-phase economic expansion.

Investment Thesis

General Motors is a best-of-breed, global automobile company. Currently, I premise we are in a late-cycle economic expansion. Therefore, now isn’t the time for automobile stocks to shine. The business is cyclical, riding the waves of economic expansion and contraction. However, trying to time the end of the expansion cycle can be very difficult.

Given the financial strength of the GM enterprise, its good management, strong franchise, and generous dividend, I am content to hold my shares through the entire cycle.

If the price falls below $30, I am likely to accumulate more, in addition to ongoing dividend reinvestment. I plan to begin to distribute part of my position if the price increases above $43.

Is The Company Well-Managed?

I contend CEO Mary Barra and her staff are doing a very good job. Dan Ammann, who served previously as the President of General Motors, recently moved into the Cruise CEO role. He is widely considered one of the best in the business. More on that later.

Management performance may be evaluated via several metrics and observations.

Return on Invested Capital

General Motors emphasizes shareholder returns. RoIC figures are presented quarterly. The stated target is 20% or greater. Below is a graph of General Motors’ return on invested capital from FY 2014 to date – 2014 marking the beginning of Mary Barra’s term as CEO.

Note to readers: Data for the following charts was taken from company reports and accepting company calculation methodology, unless otherwise noted; data points are for the full year, except for 2019, whereby half-year information is presented.

RoIC is a key management effectiveness metric.

GM offers investors higher returns than the automobile industry average and that of major competitor Ford Motor Company (F).

Automobile Gross Margins

Maintaining solid automobile gross margins indicates effective supply chain management. General Motors improved automotive gross margins immediately after Mary Barra became CEO. It was one of her earliest initiatives.

Gross margins have remained solid throughout her tenure, generally trending above 11 percent. For comparison, GM recorded 9.8% gross margin in FY 2018, while Ford Motor Company recorded a 9.3% margin. Through the first half of this year, automotive margins bumped up to 11.9%.

Administrative Expenses

Prior to Mary Barra’s tenure, General Motors’ reputation included top heavy management and an inefficient steward of SG&A expenses. In conjunction with 2014 change management, this became a focus. The results are found below.

The company’s automobile administrative expense as a function of automotive revenue has been trending down. Through the first half of 2019, General Motors’ administrative costs were 6.5% of revenue; Ford recorded a 10.2% marker.

EBIT Margins

Primarily, General Motors measures profitability by focusing upon EBIT (Earnings Before Interest and Taxes) and EBIT margins. EBIT (also known as operating income) is a good measure to evaluate how the underlying core business is functioning.

EBIT margins have been improving. Notably, North American (NA) EBIT margins peaked at 10.7% in 2017. In 2018, NA margin eased to 9.4% (adjusted for the Cruise AV business). Nonetheless, General Motors continued to maintain solid consolidated EBIT margins. This is largely a result of the company exiting longstanding, unprofitable, non-U.S. manufacturing facilities.

Managed Earnings Expectations

An attribute of a good management team is the ability to manage earnings expectations, and then meet or beat the Street. Indeed, GM is quite good at this.

Courtesy of Ameritrade

Since 2016, General Motors management registered positive earnings surprises nearly every quarter. The ability to “beat-and-raise” earnings expectations is a signal that the senior leadership team understands and can forecast near-term results accurately.

Does GM Exhibit Sound Financial Strength and Stability?

Evaluating an automaker’s balance sheet requires a bit of analysis. Most large automobile companies include a customer financing division (i.e., General Motors Financial Corporation). If so, the consolidated balance sheet may be skewed by the financing arm. Therefore, isolating the automotive balance sheet from the consolidated balance sheet is helpful.

In order to handicap GM’s financial strength, I highlighted several measures; some include balance sheet data, and others do not.

Liquidity

General Motors management tracks automotive liquidity closely. Liquidity is defined as cash, cash equivalents, marketable securities, and available credit facilities. The company targets $30-35 billion liquidity. Management states the cushion provides ample day-to-day cash and a buffer in anticipation of the inevitable economic downturn. A key objective of this policy is it includes General Motors’ ability to maintain the current dividend throughout the business cycle.

Mary Barra instituted this goal early in her tenure. The target has been met throughout the period.

Interest Coverage Ratio

The Interest Coverage Ratio is calculated by dividing EBIT by interest expense. The metric offers a view towards how well a business can service its debt. For industrial concerns, an ICR above 3x is reasonable.

For the FY 2018, General Motors automobile segment logged a 5.2x interest coverage ratio. By comparison, Ford Motor Company logged a 5.6x ICR.

Automotive Free Cash Flow

Automobile production is a capital-intensive business. Warren Buffett, a GM stockholder, emphasizes free cash flow: remaining cash available to the business after run-and-maintain capital expenditures.

GM Automotive Free Cash Flow (adjusted) – 2015 through 2019 ($B)

2015

2016

2017

2018

2019 est.

Auto FCF

2.2

6.9

5.1

3.8

4.5 to 6.0

Despite expected late-cycle weakness, General Motors continues to spin off positive automotive free cash flow. Management projects this year’s FCF will eclipse that of 2018.

By contrast, Ford Motor Company did not produce positive free cash flow in 2018, nor through the first 6 months of 2019.

Book Value Per Share

Another measure of financial stability is book value per share. “Net book” growth indicates the company is building shareholder equity, thereby creating shareholder value.

The F.A.S.T. Graph below highlights General Motors’ book value per share for the period 2014 through 2018.

Courtesy of F.A.S.T. Graphs

Through Mary Barra’s term as CEO, common equity rose ~6.6% a year. As of June 30, 2019, GM net book per share improved significantly versus 2018 year-end.

General Motors’ total shareholder equity rose 10% since the beginning of this year.

Is There A Compelling Corporate Narrative?

As the old saying goes, “The numbers tell a story, but the number aren’t THE story.”

Given that backdrop, what’s the overarching GM corporate narrative? What major management decisions and developments are affecting the business?

Since accepting the CEO role in early 2014, Mary Barra and staff reset General Motors’ corporate strategies and objectives. Here’s a short bullet point summary:

  • Run for earnings and cash flow. General Motors now seeks consistent earnings and cash flow generation. Top line growth and total unit sales are no longer the prime movers. Overhead expenses have been reduced and supply chain management improved. Lower profitability fleet sales, certain passenger car models, and compact cars were de-emphasized. High-profitability truck sales (primarily Chevrolet and GMC) are focused upon.
  • Focus on China. Currently, the GM sells more vehicles in China than into the North American market. In 2008, China vehicle sales accounted for 13% of the company’s total. In 2018, sales in the country reached 44% of General Motors’ total. General Motors must do business in China via a 50/50 JV.
  • Focus on autonomous vehicles. In the AV space, most observers say there are two clear front-runners: Waymo (an Alphabet (GOOG) subsidiary) and the General Motors Cruise division. While there remains considerable divergent thinking about the timing of the AV market opportunity, most commentators believe it will become a major driver at some point in the future. CEO Mary Barra has driven a GM stake into the ground. Dan Ammann, long recognized as an experienced, effective industry manager, heads the Cruise organization. Currently, the Cruise division isn’t profitable. The business continues to record negative EBIT, having lost $0.4 billion in 1H 2019. For FY 2018, the company lost $0.7 billion EBIT. However, the business has drawn the attention of several high-profile investors, including Honda (HMC) and SoftBank (OTCPK:SFTBY). These companies made commitments to purchase significant stakes in Cruise. SoftBank appears to own about 20% of the business, while Honda has rights to ~6%. Using cash purchase prices as a valuation metric, one could make an argument Cruise is worth between $11 billion and $19 billion. Currently, the entire General Motors Corporation has a ~$53.7 billion market cap.

It’s said Waymo is outstanding at developing an autonomous vehicle. However, General Motors has the inside track when it comes to the competencies required to manufacture, market, distribute, and sell such vehicles.

Big picture, I see GM exiting perennially unprofitable overseas markets, then redeploying the cash and capital into autonomous vehicles and EVs.

If you care to read more about Cruise, its investors, and its associated value, please see the links here and here and here.

  • Emphasize General Motors Financial Corporation. When Mary Barra took the reins, she quickly identified GMF as an underutilized asset. She sought to integrate GMF into the overall corporate strategy in a big way. In 2015, Ms. Barra’s first full year in the role, General Motors Financial Corporation generated $0.8 billion EBIT. In FY 2018, GMF doubled its EBIT contribution to $1.9 billion. This year sees the division on pace to meet or beat 2018 results.
  • Dividends and share buybacks. General Motors’ management is committed to maintaining the current dividend throughout the cycle. They speak to this frequently on conference calls, highlighting the company’s strong liquidity position. The liquidity should provide the business a considerable cash buffer during the inevitable business downturn.

In addition, under CEO Barra and the board of directors, General Motors has repurchased common and preferred shares consistently. The following F.A.S.T. Graph illustrates common shares outstanding from 2014 through 2018. The repurchase programs have reduced total shares materially.

Courtesy of F.A.S.T. Graphs

I expect 2019 will continue to show another net decline in total common shares outstanding.

  • Management versus labor relations. Under Mary Barra, General Motors management has attempted to bridge some of the “us versus them” labor versus management divide. Currently, negotiations are ongoing complete a new labor agreement; a strike ensued. Nonetheless, as the strike enters the third week, a final resolution may be near. Here’s an update.

Conclusions

General Motors exhibits the attributes I seek in a long-term investment:

  • Good management
  • Sound financials
  • Strong franchise
  • Earn profits in cash
  • Shareholder-friendly

However, as we are most likely into a late-cycle phase economic expansion, I cannot recommend wholesale share accumulation. Indeed, in the event of a recession, automakers are some of the earliest casualties.

Nonetheless, trying to time cyclical stocks is dicey. A late-cycle phase can last a long time. Recessions can be short and shallow. Therefore, I have decided to retain my GM shares (largely accumulated in 2013 and 2014 at materially lower prices than today) and ride the cycle. The generous dividend yield helps the wait. I believe management’s strategies will insulate the payout during recessionary times.

Meanwhile, I contend GM stock valuation is relatively inexpensive. New investors might decide to pick at a few shares to “get in the game.” However, such investors may need to hold through the cycle, perhaps building a position upon weakness.

A pair of F.A.S.T. Graphs illustrate how GM shares are aligned with historical valuation metrics. The first chart highlights operating earnings, and the second chart operating cash flow:

Courtesy of F.A.S.T. Graphs

Taken together, I suggest GM stock may be currently valued in the mid-$40s range. Of course, a full-on economic contraction is likely to further compress valuation multiples, while continued late-phase economic expansion could see multiples improve a turn or so. GM now has an operating P/E below 6x.

For my personal account, I plan to accumulate additional shares if the stock falls below $30. That defends my current basis. On the other hand, I am likely to distribute some (but not all) of my stock if prices reach $43.

Please do your own careful due diligence before making any investment decision. This article is not a recommendation to buy or sell any stock. Good luck with all your 2019 investments.

Disclosure: I am/we are long GM. 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.

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