It’s been a heck of a turnaround since General Motors (NYSE: GM) went bankrupt in 2009.
But GM stock is up just 12% since completing its IPO in 2010. Meanwhile, the S&P 500 is up 73% over that period.
GM has gotten a lot of press over the last 12 months. Not all of it has been good – the most recent being pressure from an activist consortium.
Activist investor Harry Wilson announced earlier this year that he was seeking a board seat at GM and wanted the company to buy back $8 billion in stock in less than a year. Wilson had the support of David Tepper, Kyle Bass and others. They collectively owned just under 2% of the automaker.
Recall that Wilson was part of President Obama’s Auto Industry Task Force when the government bailed out GM back in 2009. After just a month of back and forth, GM decided to settle with Wilson and the hedge funds.
As part of the settlement, GM will buy back $5 billion of its own shares over the next two years. Also as part of the deal, Wilson will withdraw his name from the board nominee list and refrain from waging a proxy battle.
Now, there’s reason to worry that the buyback might be too much. Will it leave the automaker with enough cash to survive another recession?
Well, for now, gas prices are relatively low, the U.S. dollar is strong, unemployment is low and there’s little to no inflation. It’s a perfect storm of good news for GM.
GM is a leader when it comes to truck and SUV models, which should benefit from cheap gas. And consumers are already willing to pay more for GM cars. Its current Cadillac CTS and various full-size trucks and SUVs are selling for more than prior generations.
Digging Deeper Into New Shareholder Friendliness
The $5 billion buyback kicks in immediately and will be completed by the end of 2016 – good enough to reduce its shares outstanding by roughly 8%. Beyond that, more buybacks could come if things go well.
And these further buybacks should not only be funded by the strong performance in the U.S., but also a robust auto market in China and a surely improving European market.
And the buyback can be done without any debt. GM has a strong balance sheet and is generating impressive levels of free cash
The strengthening business since its bailout has helped GM fortify its balance sheet over the years. It has some $25 billion in cash on the balance sheet. But GM recently noted that its ideal level of cash is just $20 billion. So it has $5 billion right there in excess capital that it can return to shareholders.
In terms of free cash flow, GM will be returning all available free cash to shareholders beyond what it needs to reinvest in the business. Plus, it plans to be much more disciplined going forward, only investing in projects that will return more than 20% on its invested capital.
The company won’t just be returning cash to shareholders via buybacks, but also dividends. It will be upping its dividend to 36 cents a share as part of its new shareholder returns policy. At $1.44 a share, its pro forma dividend yield is upwards of 3.8%, well above major peers.
GM: The Best Bet on Autos
One big overhang for GM is the ultimate fallout and cost of the ignition switch recalls. Last year, it cost GM roughly $3 billion. If we see a similar amount this year, GM should have the balance sheet capacity to absorb that relatively easily.
And by settling with Wilson, the activist investor, the company will avoid a costly proxy fight, which it doesn’t need right now.
Despite all the negative press related to recalls and the alleged cover-up of the faulty ignition switches, GM stock is holding up relatively well. It’s up 14% over the last year, having outperformed major peers Ford (NYSE: F), Honda (NYSE: HMC) and Toyota (NYSE: TM) over the last three months.
But the automaker is still attractive from a valuation standpoint.
Its price-to-earnings (P/E) ratio is less than 8, based on next year’s earnings estimates. For perspective, Ford trades at a forward P/E of close to 9, Honda is at 11 and Toyota at 10.5.
GM is still an attractively cheap stock that has upside driven by a rebounding auto market. But more importantly, it has a new capital allocation plan in place that should mean more shareholder returns for investors going forward.
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