Investors seeking potential high-octane profits via General Motors Company (NYSE:GM) may want to take a close look at GM warrants. Warrants are similar to stock call options, containing a strike price and an expiration; however, the expiration is longer-dated than regular options.
Three issues of General Motors Company (NYSE:GM) warrants were issued November 2010 in conjunction with its emergence from bankruptcy.
Why invest in GM at all?
Before considering General Motors Company (NYSE:GM) warrants, a good investor should have a reasoned investment thesis for owning GM stock in the first place. Let’s briefly look at some key strengths:
Strong cash on hand
High projected EPS growth rate and low valuation
Good free cash flow
Competitive metrics versus Ford Motor Company (NYSE:F)
Let’s break it down.
Strong cash on hand
Based upon General Motors’ most recent 10-Q filing, the balance sheet contains about $26 billion cash and marketable securities. This is equivalent to $18.86 per share, or more than half of the underlying market value of the common stock.
High EPS growth and low valuation
Wall Street consensus estimates forecast that General Motors Company (NYSE:GM) will earn $4.53 in 2014 and $5.22 in 2015. Based upon the current year consensus EPS of $3.40, earnings are expected to grow 33% in 2014 and 15% in 2015.
Assigning a normalized industry price to earnings multiple of 15 times on 2015 earnings, GM could reasonably reach $80 in two years.
Please note that post-bankruptcy, General Motors Company (NYSE:GM) management has beaten Street EPS estimates eight times, met the number twice, and missed only once.
Good free cash flow
Since emerging from bankruptcy, General Motors has been cash positive after its routine capex spending. Here’s a free cash flow recap:
| 1H 2013 | 2012 | 2011 | |
| GM free cash flow per share | $0.53 | $1.09 | $0.69 |
Figures calculated from General Motors SEC filings
Competitive metrics
Ford Motor Company (NYSE:F) did not require federal assistance during the financial crisis. Since the crisis, Ford Motor Company (NYSE:F) has completed a remarkable turnaround story. General Motors remains a turnaround story in progress.
A comparison of selected financial metrics may offer investors a precursor on how the GM journey is progressing. I’ve assembled the following table that outlines some key numbers for comparison:
GM vs. Ford: Comparison of Selected Financial Metrics (trailing 12 months)
| GM | Ford | |
| Return on Equity % | 17 | 34 |
| Return on Assets % | 3 | 3 |
| Debt to Equity % | 69 | 588 |
| Debt to Capital % | 41 | 84 |
| Gross Margin % | 6.8 | 13.8 |
| Operating Margin % | 1.4 | 4.7 |
| Net Margin % | 3.7 | 4.2 |
Figures calculated from General Motors SEC filings
While Ford Motor Company (NYSE:F) is generating better return on equity, it has come as a result of much higher debt levels. The bankruptcy process enabled GM to trim its debt to more manageable levels.
Margins indicate that Ford leads GM today. However, investors should note that General Motors Company (NYSE:GM) has seen margins improve significantly during the first half of 2013. The second-quarter 10-Q reports that first-half gross, operating, and net margins were 11.8%, 3.3%, and 3.5%, respectively.
Risks
While there appear to be a number of compelling reasons to own General Motors stock, there are risks, too.
Highly competitive nature of the business: The automobile business is highly competitive and cyclical. General Motors has been unable to improve its 11% market share since emerging from bankruptcy.
European operations: While there are signs that the EU economy has bottomed out, the necessity of restructuring European operations remains. This will be difficult given the deep ongoing recessionary climate and relatively inflexible trade unions.
Pension legacy liabilities: GM retains legacy pension underfunding liabilities of nearly $28 billion, or a 55% pension liability to market cap ratio. I consider a 20% ratio to be a yellow flag.
Investing in GM with warrants
General Motors common stock currently trades at approximately $35 a share. It pays no dividends.
Since Ford Motor Company (NYSE:F) took about five years to complete its turnaround story, one may premise that General Motors should be able to turn the same trick in no more than the same period of time, aided by its bankruptcy filing financial restructuring.
