When General Motors filed for Chapter 11 bankruptcy in 2009, it was carrying $172 billion in debt and a pension shortfall of nearly $50 billion. It represented one of the four greatest shareholder wipeouts in the history of Western Civilization, trailing only WorldCom, Washington Mutual, and Lehman Brothers in the total amount of invested capital destroyed.
Eventually, a new shareholder structure was made available to the public on November 18, 2010 when the Canadian government, United States Treasury, and the United Auto Worker’s Trust agreed to dilute/and or sell off their stakes by launching a 550 million share partial IPO of General Motors at $33 per share.
Here we are, almost six years later, and General Motors currently trades at $31 per share. The shareholders have collected $3.34 from 2014 onward, making the automaker virtually a breakeven investment. There is a paper gain of 2%, or 0.3% annualized, which amounts to a purchasing power loss when you adjust for 3-4% inflation.
While I understand why short-term investors might find a large automobile stock like Ford or General Motors attractive, I am at a loss to understand why someone would ever make a buy-and-hold commitment to a stock (or even sector) like this.
I think of it like this: The 2010-2016 period is probably one of the best conditions for owning a cyclical stock in the history of the country. Depending on which data you value, it’s been somewhere between the second and fifth best six-year stretch since the end of World War II.
This gives rise to two implications: If you can’t make money over the past six years, when can you make money? And what will your ownership position do during six-year stretches that are far less generous than the 2010-2016 period?
Now, the best argument to contradict my opinion on General Motors would be something like: “General Motors has grown earnings from $2.89 to almost $6 over the past six years. That’s a solid doubling. The story is really all about P/E compression. It traded at 12x earnings during the IPO, and now trades at less than 6x earnings. It should be considered a screaming value buy. The business performance is doing just fine, thank you very much, and the real story is about a valuation that has cheapened.”
There are two reasons why I don’t hold that opinion.
First, General Motors has completely junked out its balance sheet once again. The purpose of the bankruptcy was to slay that $172 billion debt load. The reorganized General Motors was reborn with a bit less than $10 billion in debt.
The problem? General Motors’ debt is already back up to $75 billion. It’s the same old story, repeating itself out again. Given the very favorable business climate of the past six years, the high debt accumulation should scare off any investor that knows recessions will be here again and accumulated debt balances are often the central determinant in figuring out which businesses live to see another day.
It does have nearly $18 billion in cash, but that can get burned through quickly if car demand experiences a downtick like it did in 1991, 2002, and 2008-2009. After 9/11, General Motors burned through nearly $10 billion in cash in the subsequent eighteen months. A business capable of losing $2 billion per month in tough conditions should not give you a feeling of safety when you see a high cash balance.
The important footnote, which may one day receive bold type again, is the pension. The pension shortfall of $50 billion at the time of the bankruptcy has ballooned back up to a $30 billion deficit (General Motors has $101 billion in pension liabilities and a little over $70 billion in pension assets).
The real risk with a General Motors investment is a combination of declining demand that leads to monthly losses north of $1 billion per month mixed with higher rates that make it more difficult to mask the effects of enormous debt.
Right now, it’s not an issue. General Motors is bringing in $10 billion in cash flows and the interest on the debt is only $500 million. If we re-enter a world where corporate borrowing rates go up three percentage points, suddenly General Motors will find itself with a billion-dollar interest burden.
And lastly, there is a question of P/E ratio. Even if my concerns are real, doesn’t a P/E ratio of 5-6x earnings incorporate all the bad news and provide a strong basis for future success?
I don’t think so, because I view the current quotation of General Motors as analogous to the value trap that Peter Lynch frequently talked about. He warned that deep cyclical stocks can be troublesome investments because they are cheapest when their P/E ratio is highest and are most expensive when their P/E ratio looks low.
The intuition for that opinion is that those $8.5 billion profits that General Motors is bringing in right now won’t be there in five to ten years. Since 1966, every statistical recession has caused General Motors profits to fall by at least half. This is a company that could be making $2 billion to $4 billion in the 2020s–the profits don’t have that baked in quality that is true of firms like Coca-Cola, Johnson & Johnson, or Colgate-Palmolive.
The past six years have been ideal operating conditions for the auto sector. Consumers have been upgrading their vehicles as economic conditions improve–over 85% of households that generate more than $75,000 per year in income now have a different primary vehicle than they did in 2010. The borrowing rates have been low. And, in the specific case of General Motors, it had the gift of reorganization so that many of the IOU ghouls and goblins of the past got ghostbusted.
The fat that profits only doubled while debt escalated is actually a very poor performance that does not bode well in the event that business conditions worsen. The $30 billion pension shortfall, the $75 billion debt burden, and the likelihood that future business conditions ought to worse than they are now is a reason why I would stay far away from a General Motors investment. Despite the recent bankruptcy, it would not surprise me if General Motors experienced another bankruptcy in the event that 2008-2009 scenario repeated itself. It is a stock that should only be considered for speculative or short-term accounts as it does not carry the promise of high compounding alongside the multi-decade passage of time.