GM Rising Sales Vie With Recall Woes as Stock Stays Cheap

If relative value means anything, General Motors Co. may be the best buy in the auto industry. That, at least, is the consensus of bullish analysts, who are extolling the highest-quality vehicles in decades and operating margins to go with them, even as GM suffers a record recall of cars.

GM’s shares have fallen 21 percent this year, even as its U.S. sales are the strongest since 2007 and analysts project record global sales next year. They’re trading at 7.7 times estimated earnings for the next four quarters, meaning the largest U.S. automaker is about 23 percent cheaper than Toyota Motor Corp. and 55 percent discounted to the Standard & Poor’s 500 Index. Fallout from the largest recall in automotive history is weighing on the stock and overshadowing progress Mary Barra has made since becoming chief executive officer in January.

“The quality and appeal of GM’s overall line has never been better,” said Ivan Feinseth, chief investment officer at Tigress Financial Partners LLC in New York, who has a strong-buy rating on the Detroit-based automaker. The lineup includes “some of the best quality, best looking, best performing, feature-rich cars that they have produced.”

Investors’ concerns about the recalls are one reason the stock is being “so unduly punished,” said Robert Royle of Smith & Williamson Investment Management LLP in London, which holds about 145,000 GM shares. “There’s really no justification except the headlines. Longer term, they have a pretty good product cycle coming.”

Lower Valuations

GM is valued less than peers based on enterprise value, which is essentially the sum of a company’s market value and debt, minus cash. Against a dozen of the world’s big automakers, GM’s enterprise value was second-lowest when compared to earnings before interest, taxes, depreciation and amortization. Its market cap is the lowest compared with trailing 12 month sales, according to data compiled by Bloomberg.

Ford Motor Co., which cut its outlook last month on concerns about Europe and South America, is also trading at about a 42 percent discount to the S&P 500 and par to Toyota.

“There’s some bias against American auto manufacturers, too,” said David Whiston, an analyst at Morningstar Inc. in Chicago who rates the shares a buy. “Some people have been conditioned to think that Toyota is superior or a German name is superior, and I think that’s the old way of thinking.”

One investor who has praised GM products while stopping short of a full personal endorsement of the shares: Warren Buffett.

Buffett’s Cadillac

Buffett, the chairman of Berkshire Hathaway Inc., sent a letter to Barra in May to say how pleased he was with his experience buying a Cadillac from a hometown dealer in Omaha, Nebraska.

Even though Berkshire is one of the automaker’s biggest shareholders, he explained in a CNBC interview in May that one of his deputy investment managers, Ted Weschler, made the pick. Weschler hasn’t publicly discussed his reasons for holding GM and declined to comment for this story. Buffett didn’t respond to a message left with an assistant.

Barra has introduced new pickups and sport-utility vehicles that have helped buoy unit sales 4 percent this year. Last month, she said margins will reach 10 percent next decade as European demand recovers. On Oct. 23, the automaker reported third-quarter profit that beat estimates as buyers snapped up new models and recall costs ebbed.

The market is also poised for growth because cars on the road are older than usual at an average 11 years, unemployment is falling and the economy is steadily improving, Feinseth said.

Analyst Recommendations

The results have prompted many analysts to adopt a bullish stance on GM, which had outpaced the S&P 500 with gains of 42 percent in both 2012 and 2013 before falling behind this year. Among those surveyed by Bloomberg, 58 percent recommend a buy and predict the shares will gain 24 percent in the next year, the fifth-biggest projected increase among 32 global automakers. Only 13 percent suggest selling.

Only three companies in the S&P 500 with the same or higher analyst-recommendation scores than GM have posted stock declines of more than 20 percent this year. The automaker’s shares closed down less than 1 percent yesterday at $32.27.

“We’re hoping that the perception of GM recovers from ‘They can’t do anything right,’” said Brian Johnson, a Barclays Plc analyst in Chicago who rates the shares a buy.

This year GM won six model segments, the most of any automaker, in J.D. Power & Associates’ annual Initial Quality Study. Its Chevrolet brand ranked sixth overall. In 2006, only two GM models led their categories.

50-Year Slump

Investors need to be persuaded GM won’t once again sink into another “50-year decline,” as it did last century, Johnson said. He compares Barra’s challenge to that of Alfred P. Sloan, who rescued GM from insolvency in the 1920s.

To bulls like Barclays’s Johnson, who has had a buy recommendation since GM emerged from bankruptcy in 2009, the share decline has made it an even more attractive investment.

Among other signs that GM will continue to gain momentum: 67 percent of GM’s largest suppliers are predicting sales will rise in the next year and the company charged record transaction prices for new models in the third quarter.

Barra, who has spent her entire career at GM and is the first woman to run a major automaker, at first was cheered for her promotion when Dan Akerson, a former telecommunications executive, retired to care for his ailing wife. Barra was swarmed at the Detroit auto show and sat in Michelle Obama’s box at U.S. President Barack Obama’s State of the Union speech in January.

Barra’s Spotlight

The accolades gave way to criticism after the revelation that people died because the company for years had failed to properly analyze and fix faulty ignition switches in small cars. Barra was mocked on “Saturday Night Live” and scolded by members of Congress.

Now GM is replacing the defective switches, compensating victims and trying to move beyond the crisis. The company has recalled more than 30 million vehicles in North America.

Barra has pledged that almost 40 percent of models sold globally will be new or refreshed models in 2016 and 2017, which will help drive 10 percent operating margins in North American and profit in Europe by 2016.

“It’s about execution and that’s what we’re focused on,” Barra, 52, told reporters on Oct. 1 before laying out her new plans to investors at GM’s facilities in Milford, Michigan, where the company tests new cars and trucks.

Emphasizing Execution

Barra and her top executives set a 10 percent profit margin goal by early next decade. Getting there will require margins in China to stay at about 9 percent to 10 percent, a reduction in the number of vehicle frames from 14 to 4, and successful new models.

In the meantime, GM will guard its $36.6 billion in cash, near-cash and credit lines while returning some value to investors through higher dividends. With dividend yields of about 3 percent at GM and Ford, investors are getting paid to wait for the stock to catch up with the story, Morningstar’s Whiston said.

“I think the best buy in the group is GM, and the second-best buy is Ford,” said Feinseth, from Tigress. “GM I think is just hitting on more cylinders, and the fact that they got to go through the bankruptcy, they emerged a cleaner and leaner company."

GM’s net income margin of 3.75 percent for the third quarter and 3.4 percent for full 2013 shows its improved strength. In 2006 and 2007, the last time the U.S. auto industry was this strong, GM’s net income margin was negative. Even in April 2000, when the predecessor of today’s GM had its highest share price in the last 20 years, the net income margin was 2.4 percent.

Bankruptcy’s Cleansing

GM is ‘‘much stronger on a balance sheet, with no legacy issues, and really not that much exposure to the legacy recall issues,” Feinseth said. “So pretty much all of the bad is behind them and all of the good is in front of them.”

The key for Barra will be to echo Alfred Sloan’s emphasis on accountability, said David Farber, a Temple University history professor who wrote a 2002 book on the executive who shaped GM after its 1920s crisis.

Barra may need to “throw out some of the people who had gotten used to almost a crony-like system and instead figure out a very hard metric that balances accountability and responsibility,” he said.

On Oct. 1, Barra pledged to be more impatient with executives who don’t meet goals.

Fired Executives

A 300-page report by former federal prosecutor Anton Valukas showed that GM engineers and lawyers, many of whom Barra has since fired, repeatedly failed to take defect issues to top executives or act on evidence that was presented. GM’s top lawyer, who was cleared of wrongdoing and criticized by Congress, said last month he will retire early next year.

As part of the release of the report, Barra in June decried what has been called the “GM nod,” a phenomenon where everyone in a meeting agrees to take a proposed action while leaving without any intention to follow through.

In one of her first efforts to break the complacency, Barra e-mailed her top 300 executives and asked them to answer a few questions ahead of a town hall meeting she was planning for Sept. 18. When 10 percent of the executives failed to respond by the deadline, she challenged each of them in a follow-up to explain their failure to comply.

Attacking Complacency

Barra appointed a safety chief to make sure vehicle defects are promptly relayed to upper-level management. To encourage employees to come forward, she set up the Speak Up For Safety program. It paid off in September when GM recalled 10,000 Cadillac CTS-V and STS-V models after an intern noticed an overheating fuel pump in his family’s car. Barra had lunch with the intern to recognize his initiative.

Barra has backed a plan -- controversial in Detroit -- to separate Cadillac into a new business unit and move it to New York in an effort to rebuild the brand. Cadillac has been losing market share to German and Japanese rivals for decades even with billions in new product investment. She also appointed former Nissan Motor Co. and Volkswagen AG executive Johan De Nysschen to lead the group.

Barra separated the profitable China business from the rest of Asia-Pacific to increase the focus on challenges in India and Thailand and has endorsed accounting that makes it easier to see the cost and revenue issues by region.

Pickup Production

As head of product development she led the effort to use a mid-size pickup design sold in 16 markets of the world such as Thailand, Brazil and Argentina to re-introduce the products in the U.S. They became the Chevy Colorado and GMC Canyon mid-size pickups to compete against Toyota, whose Tacoma leads the small-truck market. GM plans to add 750 jobs next year to add a third shift at the Wentzville, Missouri, plant that makes the pickups to meet demand.

The improving economy means sales of pickups and large SUVs will increase as workers need vehicles for construction and consumers become willing to spend more, said Michelle Krebs, senior analyst at Autotrader.com. “For the automakers, these are the most profitable vehicles they have,” Krebs said.

‘Healthy Impatience’

Barra said she’s trying to get GM to shake off a sense that doing well is good enough. “It’s a healthy impatience that I’m driving into the organization, pressing the business to do more, faster and have a greater sense of urgency,” she told reporters after an Oct. 13 speech in Detroit.

The bankruptcy broke GM out of “a spiral of doom” that forced it to over-produce vehicles to cover legacy costs such as union benefits and debt, Moningstar’s Whiston said. With its new balance sheet, GM can be profitable when U.S. auto sales are as low as 10 million cars and trucks, he said. Sales this year are on track for 16.3 million.

“There’s a lot more economies of scale that they could still realize,” Whiston said. “Investors can be impatient and understandably some don’t want to wait many years for this all to play out.”

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