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Amid Recall Crisis, GM Could Be Up for 50% or Greater Upside

The shares of General Motors (GM) have struggled as the company deals with its recall crisis. The auto giant has estimated $1.3 billion as the recall cost, which does not account for its tarnished reputation. Long-term investors, however, might consider this as a buying opportunity.

Although the company’s shares might continue to struggle in the short term, by the end of the year, when the crisis would be history, analysts at JPMorgan believe that the GM could rise to $52 per share, which shows a potential upside of 53% from the current levels.

The company will announce its quarterly results on Thursday. The company has reported strong sales numbers for March and has outperformed its rival Volkswagen AG (VLKAY) in China in the first three months of the current year. Analysts are expecting a 4.2% year-over-year increase in sales to $38.4 billion and a 42% drop in earnings to $0.39 per share, according to data compiled by Thomson Reuters.

Millions Recalled

GM is recalling nearly 2.6 million compact vehicles made between 2003 and 2011 with faulty replacement parts, particularly the ignition switches, which is an internal part of the ignition assembly. The recall mainly covers vehicles between 2003 and 2007, as the company redesigned the part. But the company fears that some of the cars sold between 2007 and 2011 could have been repaired with the old switch.

At least 12 deaths have been linked to the ignition problem, which is linked to the older models. The recall crisis widened this month when GM announced that it has to replace ignition lock cylinders as well on 2.2 million vehicles.

What Has GM Done?

GM has suspended two engineers for the mishap. GM is implementing a company-wide policy where employees are rewarded highlighting vehicle safety issues.

The company has also launched a website that gives the consumers all the necessary information regarding the recall.

The company has also hired former President Clinton’s director of media affairs Jeffrey Eller, claims attorney Kenneth Feinberg and Lehman bankruptcy investigator Anton Valukas to deal with the current crisis.

Cost of Recall

Initially, GM said that the recall would cost around $300 million, but that estimate has now ballooned to $1.3 billion. This cost will be recorded in the current quarter. The company might also face civil fines of up to $35 million, but that shouldn’t worry the world’s second biggest automaker with more than $28.9 billion as cash reserves (more on this later).

GM is not the only company to recall its vehicles this year. So far, GM and its peers have recalled around 9 million vehicles in the U.S. in just over three months of the current year. One of them is the world’s leading automaker and GM’s biggest rival Toyota Motors (TM) which is recalling 1.8 million vehicles in the U.S. to fix several problems. Toyota is recalling nearly 6.4 million vehicles from all around the world. If the current pace of recalls continues, then the automakers might break a 10-year-old record of 30.8 million vehicle recalls.

Bankruptcy Card

Besides the monetary costs, the recall has also badly damaged GM’s reputation as its new CEO Mary Barra faces the legislators. The company is currently facing around 30 different lawsuits on the recall issue. The crisis can also have an adverse impact on the company’s sales in the coming months, particularly in the U.S.

GM, however, might not be liable for faults in the vehicles that were sold before 2009. This is because the current GM has emerged from bankruptcy. Therefore, technically, it is a new organization and thus not responsible for the mistakes of the old GM. The victims and their families, however, can sue the shell company.

Using the bankruptcy card could save GM millions, but that could also turn into a public relations nightmare, further damaging the company’s already battered reputation. The challenge for GM here is to find a balance between lowering its costs and paying adequate compensation to the victims.

Bullish Analysts

GM’s shares have fallen by 5.8% since February due to the recall crisis. However, this could be a buying opportunity for long-term investors.

Several analysts, such as those at JPMorgan and Fitch are confident about the company’s bright future. Despite the massive size of the recall, GM had solid liquidity of nearly $38 billion by the end of the previous year. Its shares have struggled, but GM can use its strong balance sheet to reward its shareholders through dividends and buybacks.

In the coming months, if the company’s shares behave anything like those of Boeing (BA), then GM’s stock could skyrocket. Analysts at JPMorgan believe that once the dust settles, the stock could rise by as much as 53%. The investment bank has a price target of $52 on GM’s stock.

Boeing’s shares witnessed a significant drop when its planes were grounded following the Japanese airline’s battery fire incident. Boeing’s shares underperformed as compared to the S&P 500 (SPY) between January 2013, when the problem was first reported, and the beginning of March, when the National Transportation Safety Board announced that there was no structural problem with the plane. Since then, Boeing has outperformed the S&P 500.

Moreover, GM already offers a juicy dividend yield of 3.53%, which is considerably higher than the industry’s average of 2.42%, as per data compiled by Thomson Reuters.

Earnings Preview

Moreover, GM has forecast “solid core operating performance” in the upcoming quarterly results due on Thursday.

Despite the controversy, GM managed to increase its sales in March. Total sales were up by nearly 4% from last year while retail sales were up by almost 7%. GM has easily beaten analysts’ estimates, who were expecting 0.8% growth, and its Detroit rival Ford (F) that showed 3% growth in sales.

The company has also performed strongly in China, its second biggest market. For the first time in a year, GM has oversold Volkswagen in China. In the three months ending March, GM delivered 13% more vehicles to China as compared to last year as the company sold nearly 38,000 more units than its German rival.

But investors should note that overall, the company’s first quarter earnings will be lower amid the $300 million ongoing restructuring in Australia, Europe and Brazil. The company could also report an increase in expenses coming from the launch of the new full size SUVs and pickup trucks. Moreover, there is some “downside risks” coming from Argentina and Venezuela amid weakness in the economy and devaluation of the currency.

Disclosure: This article was written by Sarfaraz A. Khan, with valuable contribution from Gohar Yousuf, research assistant at Half Bridge Business Review. Neither Sarfaraz A. Khan, nor Gohar Yousuf have any positions in the stock(s) mentioned in this article.

About the author:

Sarfaraz A. Khan
Sarfaraz A. Khan is a capital market analyst and finance writer. His specialty lies in energy stocks. He also covers consumer goods, services sector, technology stocks, emerging markets and ETFs. His work appears on TheStreet, Seeking Alpha, Motley Fool and GuruFocus.

Visit Sarfaraz A. Khan's Website


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