GM - Post-bankruptcy opportunity
April 09, 2011
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RELATED TICKERS: GM
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It is well known that bankruptcy situations can be very profitable for investors. Many hedge funds focus on junior debt during the bankruptcy process and new equity afterwards, where the largest returns are often possible. Recently Six Flags (SIX) and LyondellBasell (LYB) have put up stock returns around 100% within 6 months of emerging from bankruptcy. Based on their most recent financial statement, I think the opportunity for GM shares may be as large as these 2 situations.
As often happens after emergence from bankruptcy, GM has languished over the past few months, trading below its IPO price. It is natural for former creditors who received equity to exit their positions. In addition, GM is underowned by mutual funds and individual investors because of the stigma associated with bankruptcy.
But contrary to Mr. Market's first impression, GM is in a healthy position since the balance sheet is dramatically improved. Over the past year they have cut their debt from $15.8B to $4.6B and total liabilities from $115B to $103B. Now I know a lot of people didn't like the GM bankruptcy process, but sour grapes from lousy investors is irrelevant to GM's current value. With $22B in cash and rapidly improving liabilities, GM's liquidity problems are now gone.
On to upside. Cash flow since emergence from bankruptcy has been phenomenal and far outpaces earnings. Net income available to common was $4.7B last year compared to cash from operations of $6.8B. In addition, analysts believe that earnings and cash flow will accelerate over the next few years as a result of recovery in auto demand and growth in emerging markets. Average earnings estimates are $3.95 per share for FY2011 and $4.97 per share for FY2012. Based on a 12 multiple (reasonable for their growth prospects), that translates to a share price of $60, or 90% upside from the current price in 2 years.
Furthermore, results in Q1 and Q4 were weakened by bankruptcy and IPO related costs. On a pro forma basis taking Q2 and Q3 as more typical, trailing earnings would have been closer to $7B. (Usually, this assumption would not be reasonable since US car sales are seasonal - but this trend has been overwhelmed by US and international growth, and GM sales have grown each of the last 4 quarters instead of peaking in the summer and falling.) In other words, it should be fairly easy for GM to meet analyst earnings estimates over the next 2 years.
Regarding growth, it is important to remember that GM is a global car company and their earnings will increasingly come from emerging markets. We are well into this process, with more GM vehicles now sold in China than the US.
Vehicle Sales EBIT YOY Volume Growth
North America 2.53M $5.7B 6%
Asia 3.08M $2.3B 25%
South America 1.03M $0.8B 18%
Europe 1.66M -$1.8B 0%
Obviously North America, Asia and South America are attractive businesses, while GM Europe is a mess. (To put their horrible performance into perspective, there were only around 10 companies in the world that had losses over $1.8B last year.) I think they should pursue new management, sale or partial spinoff of GME. They should also think about eliminating the Opel and Vauxhall brands, rebranding them as Buicks and Chevrolets. Any restructuring in GM Europe has the potential to bring dramatic upside.
More views on GM:
http://seekingalpha.com/article/262255-gm-upgrade-only-underlines-the-car-trade
http://seekingalpha.com/article/261941-why-gm-can-rally-50-or-more
http://detnews.com/article/20110309/AUTO01/103090334/Analyst-sees-GM-dividend-by-2013
For a good primer on bankruptcy situations, see Joel Greenblatt's book "You Can Be a Stock Market Genius" and TMFDeej's many posts on special situations. Greenblatt also refers to research which describes the high average stock performance in the year after companies emerge from bankruptcy.
I'm leaning towards buying shares of GM in the next few weeks. It is attractively priced but not the highest quality company, so my target holding period would be 1-3 years until the valuation corrects.
PS Please correct me if any of the numbers above are wrong. GM is pretty complicated, so some financial sources seem to have a tough time displaying their financial results and ratios.
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