GM with the Most Net Buys from the Gurus

General Motors (GM, Financial) has the most net buys of the gurus we follow. There have been 23 buys and nine sells, giving it a net buy of 14. The information was found using the S&P 500 Grid tool on GuruFocus.com. Most of these trades were disclosed as of 12/31/2013. Recent trades for first quarter 2014 have not been disclosed, yet. Let’s take a look at GM to see why it is at the top of the net buy list.

The GM that we are discussing is technically the new GM that started in 2009. The stock had its initial public offering in November of 2010. The new GM was able to greatly reduce debt and lower production cost. Prior to the bankruptcy, the average hourly labor costs for GM were about $25 to $30 higher than Toyota’s average cost. By 2015, the average hourly cost is estimated to be $59 for GM as compared to $56 for Toyota.[i] Coming out of bankruptcy the long-term debt was immediately reduced from $29 billion to about $5.5 billion. Also the pension liability was cut by 33 percent in 2009 and is now half of what it was in 2008.

We are still in the up cycle for the auto industry. The last down cycle was from 2006 to 2009 where the number of new vehicles sold went from 16.9 million to 10.4 million. We have yet to rebound to the previous level of new vehicle sales. In 2013 there were 15.6 million new vehicles sold. The downside for GM is that they are the only major auto manufacturer to have their market share decrease every year for at least the past 10 years. Can GM stop the slide? With the current recall and legal issues concerning faulty ignition switches, it will be very difficult to accomplish in 2014. The recalls involve the Cobalt, HHR, Solstice, G5 and Sky models.

Since GM was able to start over with a much cleaner slate, let us take a look at how the balance sheet has been holding up for the past three years. The 10-year financials can be viewed here.

Values are in millions for cash and long-term debt

The balance sheet looks like it is stable with its cash position and a very high interest coverage ratio. The negative interest charge figure in 2012 was due to large one-time items involving a $26.2 billion non-cash goodwill impairment charge according to its fourth quarter 2012 earnings release. The debt-to-equity position has been increasing to 0.85, but it is much lower than its competitors in the industry. Toyota’s debt-to-equity is 1.15 and Ford’s is 4.35. As shown in the chart, GM also has a net cash position of $6.97 billion, or $1.70 per share. Its competitors have more debt than cash.

There has been a downward trend in the return on equity (ROE) over the past three years. A three-part DuPont analysis of the ROE shows that the trend is mainly due to a reduction in net profit margin. The international operations, except China, have been a drag on profits. They took a $1.3 billion restructuring charge last year related to international operations and will take an additional $1.1 billion charge in 2014. Part of the restructuring includes closing a factory in Germany and paying severance to workers it is pulling out of Australia. If GM can reverse the downward trend in profit margins, that would cause a big positive impact on the bottom line.

ROE = (Net Income/Sales) x (Sales/Assets) x (Assets/Equity)

Today, any discussions about GM need to involve the recalls and litigation involving the faulty ignition switches. The number of cars recalled in the U.S. this year by GM is nearly 7 million. The company said that it will take a $750 million charge against earnings in the first three months of 2014 to cover the cost of all of the repairs. The flawed switch can shut off the car while driving, disabling the airbag, power steering and anti-lock brakes. The issue has been tied to at least 13 deaths. In today’s senate hearing, it was stated that the Center of Auto Safety suggests that over 300 deaths can be attributed to the faulty switch, although it has not been proven.

The situation reminds many people of the Ford Pinto fuel tank issues in the 1970s, a case that is studied in many ethics courses. It was a problem that could have been fixed with a part that costs $11 per car. There was a cost benefit analysis that materialized. It was claimed that Ford used it to compare the cost of repairs against the cost of settlements for deaths, injuries and vehicle burnouts. Barra stated that GM does not use a cost benefit analysis when it comes to safety issues.

Many of the claims might be shielded from the new GM as they could be attributed to the old bankrupt GM. GM hired Kenneth Feinberg, the lawyer who handled payouts in the September 11, 2001 victims fund and the Gulf of Mexico oil spill. Feinberg will assess what GM is liable for. Jenner & Block LLP Chairman Anton Valukas was hired by GM to internally investigate the issue as far as what happened in the production process. He previously served as a U.S. Justice Department-appointed examiner of the downfall of Lehman Brothers. In the senate hearing, Barra said that she expects announcements from investigations in the next 60 days.

In conclusion, many of the gurus bought without foreseeing the current recall issues. It could be best to sit on the sidelines for the next two months to see what the outcomes will be from the investigations. If the stock has a drop based on any findings, it could be similar to a buying opportunity after the BP oil spill and Toyota’s acceleration issues. Toyota had a drop of about 22 percent after the news broke on the problems with the accelerator in January of 2010. Since then it has passed its previous highs by about 20 percent. BP’s stock has dropped by more than half of its value. It has yet to fully recover, but it quickly bounced back at the time. GM is already down 16 percent year-to-date. There could be some more near-term downside.

As far as why the gurus bought, it looks like GM has a solid balance sheet compared to its competitors. If GM can commit to improving profit margins, then the company can vastly improve its net income. The average earnings estimate from the 17 analysts that follow GM is $4.85 per share for year ending December 2015. If the analyst expectations are correct, GM could be trading at $48.50 a share by the end of 2015 with a P/E of 10.

The gurus that are currently holding GM can be seen at GuruFocus.com. Click here to see the list.

[i] http://www.bloomberg.com/news/2012-10-18/mbdlhh0yhq0x.html