Interesting news for auto-watchers: Berkshire Hathaway Inc. (NYSE:BRK.A), the savvy conglomerate controlled by the great Warren Buffett, disclosed in an SEC filing on Thursday that it had bought 10 million shares of General Motors Company (NYSE:GM) .
That comes on top of another 15 million shares of GM Berkshire bought earlier in 2012, bringing the total value of the company’s investment in the General to nearly $700 million as of Thursday’s close.
That’s not chump change, even by Buffett’s standards. What might Berkshire be thinking?
The obvious guess for anyone who knows anything about Buffett’s career is that he (or, more likely, Berkshire’s new portfolio managers, Todd Combs and Ted Weschler) thinks that GM is undervalued at current price, particularly when viewed in the context of where the business is likely to go over the next several years
I happen to agree, which is why I own (somewhat less than 25 million shares of) GM stock myself. But it requires some explaining, because GM isn’t really undervalued by the most basic traditional measures. Its current price-to-earnings ratio is around 10.4, roughly the long-term norm for auto stocks.
But it may well be undervalued after taking into account the huge amount of room for improvement available in GM’s global operations — and current management’s determination to make those improvements and realize GM’s full value.
Big gains await GM’s Europe turnaround
GM lost $1.8 billion in Europe last year and expects significant losses to continue for at least another year or two. The problems are a lot like those GM had in the U.S. a decade ago: too much production capacity, too-high costs, and declining sales — in the case of Europe, because of a deep, protracted recession.
But GM CEO Dan Akerson has set in motion a major effort to overhaul GM’s sick European operation. A new management team is in place, a factory has been closed, another has been sold, a cost-saving joint-venture with French automaker PSA Peugeot Citroen has been established, and a bunch of new products are coming.
GM CEO Dan Akerson reiterated on Thursday that he expects GM Europe to break even on a pre-tax basis by “mid-decade”. Consider that GM made $6.19 billion in 2012. If GM had simply broken even in Europe last year, that number would have jumped to about $8 billion before taxes — with no other changes or improvements to GM’s global operations.
And the thing is, other changes and improvements are already happening.
Improvements at home are already in motion
Despite posting three profitable years in a row since its emergence from bankruptcy, GM is still very much a turnaround work in progress. It still has some catching up to do before it can match Ford Motor Company (NYSE:F) or Toyota Motor Corporation (ADR) (NYSE:TM)‘s end-to-end product quality here in the U.S. — or for that matter, Ford’s profit margins here.
But what isn’t visible to casual observers is that the work needed to narrow that gap is already happening. For the past three years, GM has been working on a full-on product overhaul that is just now hitting its stride. Products like the Chevy Cruze and Sonic small cars, and last year’s Cadillac ATS sedan, have proven that GM can design and build vehicles that really do compete well with the world’s best.
Over the next couple of years, GM will go from having North America’s oldest product lineup to its newest, as a slew of all-new cars and trucks hit its dealers. If they’re competitive – and GM’s recent track record inspires some confidence – those new products should improve GM’s average transaction prices, driving fatter margins.
The upshot: A lot of upside for GM
The case for GM isn’t quite as much of a slam-dunk as the case for Ford. Ford’s North American operation is already robustly healthy, and the Blue Oval’s proven management team is taking the same approach to restructuring its European operation, which has problems (and losses) similar to GM’s.
GM still has more challenges at home than Ford does, and unlike Ford, its management team doesn’t already have one impressive turnaround under its belt. But given GM’s still-impressive global scale, the potential upside may be considerably higher. It’s not hard to understand why Team Buffett chose to jump in.
The article Why Is Buffett Buying GM? originally appeared on Fool.com and is written by John Rosevear.
Fool contributor John Rosevear owns shares of General Motors and Ford. Follow him on Twitter at @jrosevear. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors.
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