General Motors Company (NYSE:GM) beat its first quarter earnings expectations. So far, however, the market is unimpressed. GM stock is moving down slightly in Thursday’s trading. Despite beating on revenue and blowing out revenue expectations ($1.43 vs a $1.27 consensus), GM hasn’t gotten a jolt.
In fact, the stock is back near the bottom end of its 52-week trading range. That’s despite trading at 7x trailing, 6x forward earnings and offering a healthy 4% dividend yield. So, why aren’t investors bidding up GM stock?
An Unusual Quarter
While GM beat on the main figures, it was a quarter that is hard to compare to previous ones. That’s because the company was busy overhauling its production lines. The move to convert more factories to truck production lowered revenues on the quarter.
Additionally, divestitures in Europe also lowered the company’s revenues on a year-over-year basis. Even while topping revenue estimates by more than one billion dollars, the company’s revenues fell more than 12% year/over/year, or down 3% once adjusting for exited businesses.
And despite beating on EPS for the quarter versus expectations, net income actually declined more than 50%. That’s largely due to a $900 million write-down on its South Korean business. While GM’s domestic business has shown strong results in recent years, international divisions have led to one headache after another.
The company’s automotive free cash flow generation also dipped further into negative territory.
That said, GM stock bulls can find plenty to like as well. The company showed profitability in all operating segments. Domestic vehicle sales were a strong point, rising 4% for the quarter.
Additionally, the CFO noted that the company is experiencing record performance in both China and its GM financial divisions, paving the way for the company to hit its previously-established full-year guidance. All in all, a pretty good quarter for General Motors. But given all the moving parts, it’s not surprising that the market has had a muted reaction.
GM Continues Strengthening Its Competitive Position
The write-down in South Korea is part of an unpleasant trend recently. The company is taking its lumps as it rolls back much of its bloated empire. However, this pain will lead to much stronger results for GM stock over the long haul.
The company’s grandiose state years ago, with way too many brands, scatter shot marketing, and too many foreign divisions led to an unacceptably high cost profile.
On top of streamlining operations, General Motors got major concessions from the unions regarding health care costs for retirees, saving billions. Combine with a North American division that has gone from disaster 10 years ago to profit center now, and General Motors looks set to compete.
Even acknowledging that the auto up-cycle is nearing its end, with a substantial slowdown in sales likely, GM should still be able to turn a profit. The leaner more focused operations have GM much more ready to stand its ground against the likes of Toyota Motor Corp (ADR) (NYSE:TM) and Honda Motor Co Ltd (ADR) (NYSE:HMC).
In fact, David Whiston from Morningstar estimates that GM can now breakeven at 18-19% market share in North America even if total US vehicle sales retreat to 11 million vehicles/year. That’s a huge margin of safety against the current 17 million vehicle sale run-rate.
However, GM Isn’t as Cheap as It Looks
GM stock looks like a screaming buy on several of the normal profit metrics. However, as I explained in more detail in a recent article about Ford Motor Company (NYSE:F), PE is a deceptive metric for much of the auto industry. These operators tend to have tons of debt and outstanding obligations that make the real valuation far higher than the PE ratio would imply.
On top of that, these companies rely on their financial divisions to generate much of their profits. As CFO Chuck Stevens said, it was a record quarter for GM Financial. Which means the company is making more than ever loaning money against cars.
That’s perceived to be a riskier business than actually manufacturing cars, and as we’re seeing, there are some signs of distress starting to emerge in the auto lending market.
Simply put, the market is never going to pay as high a PE ratio for a company where it is making a lot of money on potentially risky loans. Combine that with concerns about debt, union contracts, legacy pension obligations, and so on, and it’s not surprising that the market won’t pay that high of a PE ratio for GE stock.
GE Stock Verdict
That aside, it’s not hard to make the case that the market is a little too negative here. Even at a modest 9x PE ratio on next year’s earnings, GM stock would be worth 50% more than it is selling for today. The company had a lumpy quarter this time around, but the results were good and management confirmed they are on pace to hit 2018 guidance.
Importantly for yield-seeking investors, GM stock is again yielding 4% here. You don’t get that from many large American industrial firms nowadays. Combined with the share buyback, GM will return nearly 10% of its market cap to shareholders this year.
Famed investor David Einhorn of Greenlight Capital summed it up well in his latest quarterly letter:
“GM’s fundamentals appear favorable. Employment is strong, tax cuts are helping GM’s customers, used car values are performing well versus expectations and industry scrappage rates are increasing.
“GM has lean inventory and a product line-up that is gaining share with pricing power. We just don’t see what the market may be saying, and we believe that GM is more likely to exceed near and intermediate-term forecasts than to disappoint.”
While the market may end be being proven right in its skepticism, for now, this earnings report backs up the assertion that General Motor’s stock should drive ahead in coming months.
At the time of this writing, the author held no positions in any of the aforementioned securities. You can reach him on Twitter at @irbezek.
