GM Shifts Into High Gear

David Whiston: There has been a lot of good General Motors (GM) news so far this year with the stock up about 10%, easily crushing the S&P 500. We believe GM is finally on the verge of achieving the economies of scale that an automaker selling about 10 million vehicles a year should get as the company moves more product to global platforms. The proportion on global is going up to 99% by 2020 from 75% this year and just 39% in 2010. Cost-cutting moves, such as moving more supplier plants next to assembly plants to save $1.8 billion in logistics and materials costs by the end of 2016, improved manufacturing techniques, and new product, will also help.

A new development as of March 9 is that GM now has a crystal-clear capital-allocation policy which should eliminate a lot of questions previously getting asked by the investor community. Harry Wilson, who led the GM side of the U.S. government's auto task force, had the backing of four hedge funds, who collectively owned over 2% of GM's stock, to launch a proxy fight. Wilson wanted to put himself on the board and have GM repurchase at least $8 billion of its stock by the 2016 annual meeting. In February, I said this amount was too high, as GM needs to have a large cash hoard to protect itself against the highly cyclical nature of the auto industry. We had been modeling $5 billion of buybacks, split evenly across this year and next. And GM, on March 9, made several announcements justifying our expectation.

First, GM will indeed buy back $5 billion of its stock before the end of 2016. We do not see it taking on new debt to do this, however, because the company had automotive cash at year-end of $25.2 billion. The company will now reduce its automotive cash target to $20 billion from $20 to $25 billion previously. Most important is that all free cash flow above what is needed to reinvest in the business to earn ROIC of at least 20% and maintain an investment-grade balance sheet with $20 billion of cash will be returned to shareholders going forward. We had not seen this type of clarity before, and we like it a lot. We expect these payments back to shareholders will come via both a sustainable dividend and buybacks beyond the $5 billion announced March 9.

So, we see this announcement as very favorable for GM shareholders as it reduces an asset that is earning a near-zero return on the balance sheet, while not drastically raising GM's risk profile. The company also has $12 billion of credit lines it can tap in an emergency, so we think buying back what we see as a very undervalued stock makes sense. Furthermore, returning all free cash flow to shareholders after reinvesting in the business and keeping a strong balance sheet is tough to argue with--even for activist shareholders. Harry Wilson, by the way, is dropping his shareholder resolutions.

To sum up, this Best Idea is growing profits and margin, thanks to more efficient manufacturing and great product. GM is returning cash to shareholders while keeping its balance sheet strong, and shareholders are paid to wait with a dividend yielding nearly 4%. We think people that ignore the new GM are missing an opportunity to get alpha in a market where bargains are scarce.