GM, Ford Should Double in Value With High Margin of Safety
David is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
Value investors have been hailing the value of Ford (NYSE: F) and General Motors (NYSE: GM) for some time now, but both stocks have simply failed to perform. Since the start of 2011, both companies have lost 44% of value; over the last six months, they have lost 20% in value; over the last month, they have lost 10% of value. This is even more inextricable in light of generally better-than-expected performance.
Over the last five quarters, Ford has beaten consensus by an average of 4.5%. The company had a large 25.9% miss in 4Q11, but occasional disappointments are to be expected when your company is in "turnaround mode." The main point is that the company is improving free cash flow but has nevertheless seen a contradictory dramatic decline in shareholder value.
The case is even more bizarre at GM. The company had just a 7.1% miss in 4Q12 and beat consensus by an average of 7.2% over the last five quarters. One would expect it to then outperform Ford, but it has had relatively the same performance in the one direction it didn't deserve: down.
Both companies are great value investments that are an excellent way to play a quicker-than-expected recovery. They are highly volatile auto producers and thus extremely susceptible to economic swings, which has probably overwhelmed the improving fundamentals. As it stands, GM and Ford have little downside and great upside relative to foreign peer Toyota (NYSE: TM). I rate the American producers "strong buys" and the Japanese producer a "buy."
Ford has already showcased an affinity towards generous capital allocation policies with its 2.2% dividend yield in an uncertain economy and its recovery from the brink of bankruptcy. It trades at just 5.7x forward earnings and has an extremely low PEG of 0.25, which indicates that future growth expectations have been nowhere close to factored into the stock price. Analysts expect the company to grow EPS by just 7.8% annually over the next five years. This means 2016 EPS of around $2.03. At a 12x multiple, the future stock value of the company is $24.36. A 12% discount rate would give the firm a $13.82 price target, which is at a nearly 50% premium (margin of safety) to the current market value. It would take a discount rate of 20% for the firm's current justification.
A few things to note: My "optimistic" discount rate of 12% is actually fairly high considering that it is in reference to poor single-digit growth and a multiple of just 12x. The chances that Ford meets and exceeds these inputs is much more likely than not, so a discount rate of 10% is more reasonable and would place the price target at $15.12, or a 65% premium to the current market value. Additionally, the Street is similarly bullish on the stock and gives it a price target of $14.42. A recent report from Standpoint Research upgraded the company from "hold" to "buy" with a $17 price target. I thus strongly recommend an investment in this turnaround play.
GM is similarly undervalued. Thanks to government carrying the company by the hand, the auto producer is replete with cash. It has $31.5 billion in cash and $17.2 billion in net cash - the latter of which represents more than half of market capitalization. At a PEG ratio of 0.42, the market has failed to factor in growth and there is great likelihood that cash holdings will eventually become fully appreciated.
I am not quite sure why the market has so disregarded GM's cash treasure, especially when you consider that Toyota has $124.8 billion in net debt but is worth approximately 4x more. Moreover, GM generated 2.6x the amount of net income that Toyota did last year.
At the same time, GM has also done better in improving earnings than its Japanese peers. Investors appear to be overly wrapped up in the US auto collapse, since GM trades at just a respective 5.7x and 4.5x past and forward earnings while Toyota trades at a respective 33.9x and 9x past and forward earnings. Furthermore, only Toyota has had growth properly factored into the stock price with its PEG of 1.
Under current growth forecasts, GM will trade at $73.63 under a 12x multiple. Discounting backwards by 12% yields a present stock value of $41.81 - more than double the current valuation! It would take more than an absurd 30% discount rate for the company to be fairly valued. Analysts currently rate the stock a "buy" and give it a $32.53 price target. Despite negative market movements, UBS reiterated its "buy" rating with a $30 price target. If GM is not on your "buy" list, it should be.
To get a sense of just how undervalued Ford and GM are, consider Toyota, which is also a great company. The foreign producer offers 1.6% dividend yield and is exposed to the same secular trends but has considerably less volatility than not only Ford and GM but also the broader market with a beta of 0.73. Considerable annual growth is expected in the years ahead, but ROA, ROE, and ROI are next to 0% while its American peers are in the high single-digit to double-digit territory for these metrics. Investors are advised to capitalize off of domestic economic uncertainty, which has overwhelmed fundamentals. GM and Ford may not only double in value, they also offer a higher margin of safety than their competitors do.
TakeoverAnalyst has no positions in the stocks mentioned above. The Motley Fool owns shares of Ford. Motley Fool newsletter services recommend Ford and General Motors Company. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.If you have questions about this post or the Fool’s blog network, click here for information.
