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.
Therefore, GM should stand tall no later than 2016.
If there was an investment that could control shares of GM stock into 2016, yet only require putting up a fraction of the capital versus buying common shares, it would seem like a good deal, right?
Well there is a way to do just that.
General Motors warrants are similar to owning long call options, but with a longer expiration date. Owners have the right to exchange one warrant for one share of common stock at a specific price within a stated period of time. General Motors has three such listed issues:
General Motors Warrants
| Ticker | Recent Price* | Strike | Expiration |
| GMWS-A | $26.35 | $10.00 | 07/10/16 |
| GMWS-B | $18.71 | $18.33 | 07/10/19 |
| GMWS-C | $4.15 | $42.31 | 12/21/15 |
*GM corresponding common stock price $35.85
The A and B warrants are “deep in the money,” meaning that the strike price is significantly below the current stock price. The warrant “premium” above the recent share price is small.
For example, GM “A” warrant owners have control of underlying GM common shares for nearly three years with only two-thirds of the capital outlay — all for a premium of only $0.50.
The C warrants are “out of the money,” meaning that GM stock must reach $42.31 before they have any value. The entire warrant is composed of premium. There is no current intrinsic value.
Foolish bottom line
General Motors Company (NYSE:GM) warrants offer investors the opportunity to participate in a great American corporate turnaround story at a fraction of the price of buying the common shares outright.
GM is flush with cash, has manageable debt levels, and has demonstrated the ability to generate positive free cash flow. Strong forward earnings estimates are coupled with a demonstrated ability to meet or beat the Street. Margins are improving, approaching those of Ford Motor Company (NYSE:F).
Nonetheless, General Motors securities remain speculative. The automobile business is cyclical and highly competitive. In addition, a weak EU economy and legacy pension liabilities pose risks to the investment thesis.
The article Can General Motors Warrants Turbocharge Your Portfolio? originally appeared on Fool.com and is written by Raymond Merola.
Raymond Merola owns General Motors “A” warrants. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford.
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