Inside Wall Street: Why GM Investors Could Be Cruising in the Fast Lane

Gene Marcial's Inside Wall Street
Gene Marcial's Inside Wall Street

Thanksgiving Day may be just behind us, but one company that investors should continue to be thankful for is General Motors (GM). Yes, GM. The transformation of the old carmaker into the entirely different and streamlined new GM in such a relatively short period is near-miraculous, if not totally miraculous.

Investors have two reasons to be thankful for the new GM: Its reemergence after filing for bankruptcy in July 2009 gives the U.S. another opportunity to be a leader once again in the fiercely competitive global auto industry. And the new GM will certainly make big bucks for investors if it fulfills its potential to beat sales forecasts and earnings expectations.

No, GM wouldn't need another miracle to do that. Simply stated, the much-improved auto company is tailored to do just that. No less than the global investment research outfit Morningstar argues that the new GM "will be printing money" when industry sales pick up, thanks to its more efficient and low-cost operations and new lineup of auto brands.

Industry Volume Could Be Key

In a comprehensive report on the new GM, dated Nov. 17, Morningstar said it expects GM to post "excellent earnings growth as vehicle demand comes back over the next few years." Here's how Morningstar expects that to pan out: GM's North American breakeven point is industry sales in the range of about 10.5 million to 16 million units. Morningstar figures that normative demand for U.S. light vehicles is about 16 million to 17 million.

"If we are right about volume recovery, GM's high degree of operating leverage means the firm will be printing money when sales recover," says Morningstar, which estimates the fair value of the new GM's stock at $46 a share. The stock closed on Nov. 26 at $33.80 a share.

GM finally returned to the New York Stock Exchange -- after 17months of being in bankruptcy -- on Nov. 18. Shares of the new GM opened trading as an initial public offering at $35 a share, $2 above its IPO price, and closed at $34.19, after hitting a high of $35.99.

The much-heralded IPO produced $18 billion, much more than GM had expected, making it the second-largest IPO in U.S. history, after Visa's (V) IPO of $19.7 billion in 2008. GM now has a market capitalization of $51 billion, compared with Ford Motor's (F) $58 billion, which has been steadily profitable even though it refused to ask for any government financial aid.

"Dramatically a Different Company"

The government invested $49.5 billion in GM as part of a bailout to help turn around the ill-starred automaker in exchange for a 61% stake. The IPO helped the U.S. Treasury, which sold some of its shares in the offering, to reduce its holding to a minority stake of about 26%. Treasury won't be doing any more selling over the next six months but would do so thereafter. That should finally quell the gibe that GM stands for Government Motors. Indeed, after begging for dollars, GM is now making money for the first time in six years.

The new GM is "dramatically a different company than old GM," notes Morningstar. It has reduced its core brands to four -- Chevrolet, GMC, Buick and Cadillac -- from eight. Globally, it has 12 brands and operates under three segments: General Motors North America, General Motors Europe and General Motors International Operations. The GM International accounts for the largest sales among the three divisions, with 49% of volume. GM North America comes in second with 31% and GM Europe has 20%.

In North America, GM's Chevrolet brand produces the largest unit volume, with 70% of the output. In China, where GM has joint ventures with Chinese auto makers, Buick is a luxury-brand big seller. Indeed, it's more popular in that country than in the U.S.

Finally, Compelling Financials

How competitive are GM's brands compared with those of other global producers? From early reports, GM's lineup stands out quite well. "GM's car models have their best quality and design in decades," notes Morningstar. The research entity adds that GM is already a leader in truck models. So, a fully competitive lineup combined with a much smaller cost base "lead us to think that GM will be printing money as vehicle demand recovers."

On its financials, long a problem at the old GM, the picture also provides some pleasant reading. Standard & Poor's auto industry analyst Efraim Levy notes that GM emerged from its bankruptcy with reduced operating and borrowing costs, and with a greater focus on its remaining vehicle brands.

"With our forecast for rising industry sales volume in the U.S. and most other regions in 2011, partly offset by higher raw material costs, we expect the company to generate earnings of $3.62 a share in 2011," up from his estimated 2010 forecast of $2.78. But Levy remains neutral on GM in his initial coverage of the stock, rating it a hold.

Promising New Models

Some investors continue to be irate at GM for allowing itself to deteriorate to a point where it had to beg for bailout succor from the government. And others, like Levy, worry that the recovery in global vehicle demand remains uncertain, and that stiff competition from foreign automakers including Hyundai and Volkswagen could make things difficult for the new GM.

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But the new-GM bulls point out that models like the Chevrolet Malibu and Chevrolet Cruze already demonstrate how GM has been able to compete directly against Japanese and European brands. "GM already is a top player in critical emerging markets such as Brazil and China," says Morningstar. GM currently sells about 70% of its vehicles outside North America.

Analysts at Morningstar forecast higher earnings for GM compared with S&P's. They figure GM will earn $5.8 billion, or $3.02 a share, in 2010 and $7.1 billion, or $3.72 a share, in 2011. Morningstar expects revenues to reach $122.5 billion in 2010, rising to $139.9 billion in 2011.

Although some possible headwinds still confront the new GM, it may be folly to totally ignore the growth prospects of this once-mighty top dog in its metamorphosed structure. Wall Street, so far, hasn't totally embraced the transformed automaker. But for now, that may be a good thing for investors who want to sprint ahead of the herd.

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