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Friday, February 1, 2013 - 10:00
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Friday, February 1, 2013 - 10:00
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Friday, February 1, 2013 - 10:00

David Einhorn Is Bullish On General Motors. Should You Follow Suit?

Friday, February 1, 2013 - 10:00am

It seemed unthinkable at the time, but the writing was on the wall…

In 2009, General Motors (NYSE: GM) filed for bankruptcy protection, becoming the fourth-largest bankruptcy in U.S. history. The company only had $82.29 billion in assets to cover its $172.81 billion debt.

Even an almost $30 billion bailout by the federal government couldn't save the doomed car maker, and plans were made for heavy factory closings and the loss of more than 20,000 jobs.

Fast-forward to today, and renowned investors like David Einhorn, president of hedge fund Greenlight Capital, are touting GM as one of their top stock picks for 2013.

What gives? And more important, should you follow suit?

Let's start with the good news…

GM is trading for bargain prices
In Novemeber 2010, the restructured automaker pulled off the biggest IPO in U.S. history, raising $20.1 billion through the sale of 478 million common shares at $33 each. By June 2012, shares had dipped below the $20 range for the first time since the IPO. It finally hit bottom in July, at just below $19 per share.

Since then, shares have been on the rise. Fueled by strong 2012 third-quarter earnings report, in which net revenue rose by $1 billion, shares finally broke through resistance at $28. Since July's bottom, they've gained more than 50% and recently topped the $30-mark before taking a breather.

Yet, even after the rise, when compared to earnings, the stock is still inexpensive.

GM's forward price-to-earnings (P/E) ratio, which is used to compare a company’s current share price to its expected per-share earnings, is just a little more than 5.

That's an incredibly low price for a company that owns iconic brands such as Cadillac and Chevrolet.

U.S. car and truck sales are on the rise
U.S. new car and truck sales rose to a four-and-a-half year high in 2012, with more than 14.5 million units sold. Industry insiders are predicting 2013 will be even better, with sales climbing to 15.5 million units this year, according to automotive forecasting firm Polk.

As you might expect, with rising sales, GM's revenue has grown steadily the past three years from $104 billion in 2009 to more than $150 billion last year.

But what's even more telling is the change in GM's free cash flow.

Free cash flow is a measure of how much cash a business generates after accounting for capital expenditures, such as buildings or equipment. This cash can be used for expansion, dividends, reducing debt or other purposes.

In 2009, the company reported a negative cash flow balance of more than $22 billion dollars, as the cost of restructuring and paying off debt destroyed the bottom line.

Although last year the numbers trailed the previous year, GM still posted almost $2 billion in free cash flow. This is a good sign that the company is on a solid footing and could even begin paying a dividend if profitability continues to rise.

GM is far more diversified than most investors realize
GM, a brand synonymous with American workmanship, actually sells nearly 70% of its vehicles outside North America.

The company is already is a top player in emerging markets, particularly the so-called BRIC nations -- Brazil, Russia, India, and China.

GM's Chevrolet is currently the world's fastest-growing automotive brand. Chevrolet sold almost 5 million vehicles in 2012, setting a new global sales record for the company.

Now that we know the good news, let's take a look at some of the reasons investors are still wary of GM...

Questionable management
GM has undergone considerable restructuring since its bankruptcy and bailout. So in many ways, it would be unfair to judge current management's capabilities based on the old management's failures.

Still, the company has already had three different CEOs at the helm since 2009. Two-thirds of its board members are new, and there are questions as to how much experience the new leaders have in the automotive industry. For example, Dan Ackerson, the company's latest CEO, is a veteran of the telecommunications industry and worked with Carlyle Group before coming to GM.

While I believe GM definitely needed major restructuring, investors tend to get jittery when a company's top brass play musical chairs too often.

One positive note to consider: GM's board of directors voted to buy back 200 million of the U.S. Treasury's 500 million shares last December. They realized the stock was undervalued and acted accordingly. This is the kind of action investors like to see, and I would keep an eye out for similar actions in the future.

Trouble in Europe
Despite the recent success in North America and in developing nations, GM's European division is still having trouble. The division is losing $1 billion per year and Stephen Girsky, the vice chairman in charge of fixing the problem, has predicted this division will not break even until mid-decade.

To be fair, part of the reason for that division's slump is systemic -- European car sales have recently fallen to their lowest levels in almost 20 years, because of the eurozone economic crisis.

Action to Take--> If you are a contrarian investor who revels in beaten-down stocks that are in an upturn, then GM is a great "buy" at current levels. If you are the type of investor willing to be patient while management proves itself and the auto industry continues its rebound, then GM is worth further research.

Chad Tracy does not personally hold positions in any securities mentioned in this article.
StreetAuthority LLC does not hold positions in any securities mentioned in this article.