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MegaEurope (< 20)

GM - Post-bankruptcy opportunity

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April 09, 2011 – Comments (18) | RELATED TICKERS: GM , SIX , LYB

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.

18 Comments – Post Your Own

#1) On April 09, 2011 at 7:58 PM, MegaEurope (< 20) wrote:

Recently Six Flags (SIX) and LyondellBasell (LYB) have put up stock returns around 100% within 6 months of emerging from bankruptcy.

Correction, within 1 year.

GM's time frame for a rebound will probably be slower than these because of the share overhang from the federal government and former creditors.  It will probably be a good idea to average in to this position since it may drop further in the short term.

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#2) On April 09, 2011 at 8:18 PM, lquadland10 (< 20) wrote:

Don't forget they are now having problems getting car parts from Japan.

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#3) On April 09, 2011 at 8:25 PM, MegaEurope (< 20) wrote:

Their Asian competitors are having much bigger problems.

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#4) On April 09, 2011 at 8:45 PM, ikkyu2 (99.15) wrote:

Does the fact that they have $103B in liabilities raise no eyebrows other than mine?  How are they supposed to earn their way out from under that?

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#5) On April 09, 2011 at 8:45 PM, ikkyu2 (99.15) wrote:

Does the fact that they have $103B in liabilities raise no eyebrows other than mine?  How are they supposed to earn their way out from under that?

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#6) On April 09, 2011 at 9:27 PM, MegaEurope (< 20) wrote:

Ikkyu, of course the balance sheet is worth looking at closely.

It's unnecessary for an ongoing company to earn its way out of all its liabilities.  After all, current assets outweigh current liabilities and likewise for long term assets and liabilites.  All that is necessary is to pay the interest payments and preferred share dividends, then the remaining cash flow is left over for common shareholders.

But anyways, I suppose the answer to your question is "one year at a time."  It would take Berkshire Hathaway around 16 years for current earnings to wipe out liabilities, compared to 22 at GM (and I think GM's earnings have significant upside over the next few years).  Not so bad.

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#7) On April 09, 2011 at 10:40 PM, portefeuille (99.60) wrote:

They should also think about eliminating the Opel and Vauxhall brands, rebranding them as Buicks and Chevrolets.

No idea how that would be helpful. In Europe U.S. car brands are even less valueable than the "Opel" brand, hehe ...

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#8) On April 09, 2011 at 11:02 PM, MegaEurope (< 20) wrote:

Porte, that might be true but you can't really tell unless you try it. GM was highly successful introducing Buick in China and Chevrolet in Brazil.

Anyways, given the strength of the local car industry German appreciation for GM brands is probably a lost cause.  Maybe new brands could work in Spain or Russia.

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#9) On April 10, 2011 at 2:36 AM, awallejr (81.55) wrote:

I could never understand why anyone would want to invest their money in GM. Even after bankruptcy the company has its problems.  It is hardly a growth company nor does it return any dividends.  Seriously, move on, let some other sucker throw his money away.

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#10) On April 10, 2011 at 1:02 PM, Valyooo (99.41) wrote:

GM is always in and out of bankruptcy and losing tons of money and needing a crapload of debt.  Plus there are billions of people trying to figure the stock out.  Why not just scrap GM and look at another company?  Unless you truly think GM is the best investment on the planet

I never understood why people like to try to figure out the most difficult situations instead of going for the easy ones which yield the same returns if not better

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#11) On April 10, 2011 at 2:33 PM, MegaEurope (< 20) wrote:

GM is always in and out of bankruptcy and losing tons of money and needing a crapload of debt.

You need to read the financial statements - or at least my summary of them.  They spell out how profitable the company currently is, how much it's growing and how much the debt load has been reduced.

Maybe bankruptcy emergence is not the right strategy for you, but GM is definitely popular with hedge funds like Appaloosa, Pershing Square, Blue Ridge and Soros. http://seekingalpha.com/article/257151-10-stocks-hedge-funds-are-buying-like-crazy

If you know of any easy situations that you believe will return 90% over the next 2 years, let me know.

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#12) On April 10, 2011 at 3:20 PM, Valyooo (99.41) wrote:

My point was looking at their history...they are always troubled.  I am not sure why people love crowded trades with companies that have struggled for their entire existence.

I do believe post bankruptcy situations can yield great returns, but SIX was a lot less followed than GM.  I wish you the best of luck I just see this company as one with poor long term economics that has too many eyes watching it.

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#13) On April 10, 2011 at 4:56 PM, MegaEurope (< 20) wrote:

How do you measure whether the trade is crowded?

Compared to Ford, they have less than half the number of institutional investors.  Compared to Six Flags, they have 5x the number of institutional investors - and 25x the market cap.  Coming out of bankruptcy as an "orphan equity", it rarely makes sense to claim that a trade is crowded.

http://finance.yahoo.com/q/mh?s=GM+Major+Holders

History is important but pre-bankruptcy results are a lot less important than post-bankruptcy.  Both the capital structure and the cost structure changed dramatically over the last year.  And auto manufacturing has not actually been a terrible business over the long term.  See page 18 here.

http://mkqpreview1.qdweb.net/PDFDownload.aspx?ar=1714

I'm guessing you don't believe that they can earn $4.97 a share in 2012.  Can you explain why not?

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#14) On April 10, 2011 at 6:01 PM, Valyooo (99.41) wrote:

My measure of how GM trade is crowded is that I see it on almost a daily basis on CAPS, yahoo finance, bloomberg, and CNBC, and people that know nothing about finance ask me if they think GM is a good investment.

While on the other hand, the only mentions I have heard of six flags post bankruptcy are from you and TMFDeej

Car companies in general have had profitability problems for a very long time...I can't find a long term historical chart right now but I remember reading from Lynch and Buffett that a good year for GM is one in which they actually make a profit.  Supply chain disruption in Japan does not help much either.

On top of all  of that, I think the cars are pretty crappy.  But I am no car expert.

This wasn't meant specifically for GM.  I just mean in general when a company has a lot of eyes on it, and there is a lot of uncertainty with it combined with a bad history, why people spend so much time analyzing it when there are so many other good companies out there.

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#15) On April 10, 2011 at 6:28 PM, Option1307 (29.75) wrote:

Nice write up, +1.

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#16) On April 10, 2011 at 8:17 PM, MegaEurope (< 20) wrote:

Well, I think you're right that despite their profits GM North America has significant operational issues they need to address.  But I think the biggest problems are attractive design and marketing - not build quality.

http://seekingalpha.com/article/145276-how-does-automakers-car-quality-rank

Relative to its size, GM is underfollowed on CAPS although maybe not on Bloomberg and CNBC.  Twice as many people have green or red thumbed F in the last 4 months as have thumbed GM.  There haven't been many blogs either.

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#17) On April 11, 2011 at 7:06 PM, MegaEurope (< 20) wrote:

I also suspect that the US government will not be selling much of its stake below breakeven ($53), at least until after the 2012 elections.  Losing money on the shares would be a black eye for the White House.  The same might be true for Canada, and the UAW is probably not in a big hurry to sell either.

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#18) On August 27, 2011 at 4:04 PM, MegaEurope (< 20) wrote:

According to Wikipedia, US breakeven is actually around $44.

http://en.wikipedia.org/wiki/General_Motors 

There has been more selling pressure than I expected.  I think I will start a position this week. 

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