GM), which went public again in late 2010, with analysts painting a fairly rosy picture for the years ahead. Indeed, at the start of this year, I noted that analysts at Morgan Stanley thought GM's stock might hit $100 in a few years.it the non-event of 2011. This was supposed to be the year investors re-embraced GM (NYSE:
At the time, I suggested investors take such a lofty prediction with a grain of salt: "A reason to be a bit cautious on Morgan Stanley's very aggressive price target: That target implies an uninterrupted path of global economic growth for the next four years. And few want to make that bet."
As recently as August, I compared Ford (NYSE: F) and GM on a head-to-head basis and concluded that although both stocks were equally cheap, Ford was the better bet, thanks to a vastly superior management team. Shares of GM have slid 18% since then, while shares of Ford have risen 3%. I still think Ford makes for an excellent long-term investment, but I now think GM actually represents the better short to mid-term trade. Here's why...
A changing tide
The key to contrarian investing is to anticipate a shift in sentiment. It's not enough that a stock is cheap (and GM surely is at around 5.5 times projected 2011 profits). Instead, you need "cheap -- with catalysts." And GM has them. You won't necessarily find them embedded in 2012 earnings per share (EPS) forecasts, because per-share profits are likely to be flat next year at about $3.90. Instead, in 2012 shares will likely respond to what investors anticipate in 2013 and beyond. Indeed, GM's 40% drop from the 52-week high this year is in anticipation of a worsening near-term outlook for 2012 and a fairly thin product pipeline of new vehicles.
But that's about to change.
GM had to conserve cash in 2008 and basically starved resources from the engineering team. The company did an admirable job of keeping its line-up reasonably fresh in subsequent quarters, but rivals such as Ford, Hyundai and others have done an even better job. Yet the company's stronger financial position during the past year or so has led to acceleration in new product development that should be pay off later in 2012 and especially in 2013.
For example, the company's bread-and-butter Malibu sedan will hit showrooms next year with very favorable early reviews thus far. The fact that this roomy sedan will get nearly 40 miles to the gallon on the highway tells you that GM's inability to design efficient vehicles is a thing of the past.
More importantly, GM had been ceding ground to Ford in the highly-lucrative truck segment, thanks to fresher models from Ford. Ford's truck sales rose 21% in November from a year ago, while GM's truck sales rose just 5%. But help is on the way. A new Silverado, which is the platform for the bulk of GM's truck sales, will be released in 2013, and the company is expected to boost the truck's design and fuel efficiency. Also, GM is set to once again aggressively target the small truck market with a bold new Colorado truck model.
The timing may be fortuitous. Recent employment trends have led some to think new home construction may finally, finally turn up in 2012. Contractors, armed with stronger income, are expected to spend heavily to upgrade their aging truck fleets.
Costs and cash
Perhaps the strongest argument for GM can be found on the company's balance sheet and income statements. Though it's often-mentioned, it's worth repeating that GM now has nearly $40 billion in net cash. The whole company is valued at just $33.6 billion on the stock market. Is this business really worth -$6 billion? Selling for less than net cash implies some sort of imminent implosion of this business. I just don't see it.
In fact, GM stands to make money in the toughest of sales environments. Recent new labor agreements will take GM's costs even lower. The company agreed to 2%-3% annual wage increases, according to UBS, but any new hires will be brought in at far lower labor rates than existing employees. As GM's veteran higher-cost employees retire, that average hourly rate is likely to rise even more slowly than the agreed upon 2%-3% figure.
Material costs are also set to drop in 2012. Steel prices appear to have peaked last spring at roughly $880 per ton of hot-rolled steel. We're exiting the year at about $625, which should help lower costs for all automakers in 2012..
So why are shares so cheap in the face of these tangible positive factors? Well, the view beyond our shores remains murky. North America will be the bright spot for the auto industry in 2012 as other economies work though their own problems. Investors simply don't know how bad things will get in Europe, but it's worth noting that cars eventually wear out, and GM is retaining market share. So 2012 may be a challenge for GM's European operations, but with a bullet-proof balance sheet, the direst outlooks are overblown. The longer-term outlook for Europe and Latin America will surely improve, and shares should start to anticipate better days ahead.
Risks to Consider: Tight costs, lots of cash and a soon-to-be-freshened product line-up may not be enough to inspire investors until Europe's storm has truly passed, so shares may mark time for a while longer.
Action to Take--> This is all about risk and reward. With a cash-rich balance sheet in place, it's hard to see how GM can fall any further. If that were to happen, management must, must, must implement a share buyback plan. Selling for less than net cash already is an unconscionable state.
What kind of upside are we looking at? There's no reason to think GM can't earn $5 a share by 2013 or 2014. Slap a multiple of eight on this forecast, and shares could nearly double from current levels to about $40. It may take two, four or even six quarters for that to happen, but the stars are coming into alignment for a long-awaited rebound.