General Motors Company: Is This Stock a Buy?

By Markets Fool.com

General Motors product chief Mark Reuss showed off the all-new 2016 Chevrolet Malibu in New York last month. The Malibu looks set to add to GM's recent string of new-product successes when it debuts this fall. Source: General Motors Co.

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General Motors missed Wall Street's expectations when it reported first-quarter earnings of $945 million last month. The stock fell about 3% on the news, and it has fallen further since.

Was that drop justified, or is this a buying opportunity? That depends on your expectations. But if you're a patient long-term investor, there's a good story unfolding here that might make this a good time to buy GM.

GM has a big opportunity for profit growth
Here's the story in one sentence: Six years removed from bankruptcy, GM is solidly profitable, with strong financials and a good credit rating -- but it's also still a turnaround story that could grow profits significantly over the next five to seven years.

General Motors' products and finances have come a long way since bankruptcy, but the company still hasmuch work to do to capture its full profit potential. While GM made $9 billion in earnings before interest and taxes last year (if you don't count the $2.4 billion it spent on all those recalls), its two closest global peers have been making a lot more: $14.3 billion in operating profit for Volkswagen Groupin calendar 2014, and a whopping $22.6 billion for Toyotain its most recent fiscal year, which ended on March 31.

That profitability gap has plagued GM for years, but CEO Mary Barra sees it as an opportunity.

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Barra's plan to seize that opportunity
Last fall, Barra and her team laid out a plan to boost GM's profits to rival those of Toyota and VW.Barra hopes to increase GM's adjusted pre-tax profit margin to between 9% and 10% by "early next decade" (it was 5.8% last quarter).

Her plan has several key components:

  • Substantial investments in products and technology. General Motors bumped its annual capital expenditures to $9 billion (from $7 billion in 2014) to fund a more aggressive new-product schedule. It's also funding the development and implementation of some advanced technology that will reduce the weight of those products and improve their fuel economy. The company is also making major strides in self-driving technology, and with electric cars and hybrids.GM has been playing catch-up on a number of these fronts for a long time, but in some areas it's now in the forefront, and its still-mighty (and long-overlooked) research and development units are pushing it ahead very quickly. The scale that GM can bring to bear on technological challenges dwarfs that of nearly all of its rivals, and Barra is determined to make the most of that advantage.
  • A massive transformation for Cadillac. The company expects the global market for luxury cars to grow significantly over the next few years, led by the three big German luxury brands. But GM wants Cadillac to be a first-rank player -- in prestige if not in total sales. It is spending $12 billion on new models and upgrades for the old brand.General Motors doesn't want (or need) Cadillac to challenge class leader BMW'ssales volumes, but it does want to get the brand up to 500,000 sales by 2020 from about 264,000 in 2014.
  • More growth in China. GM already has a massive presence in China, trailing only VW in total sales. But it's making big investments for future growth. GM and its Chinese joint ventures will spend $14 billion from 2014 to and 2018opening five new factories and introducing 60 new or refreshed models.
  • Boosting GM Financial. General Motors wants its in-house financing arm, GM Financial, to become a major global profit center. It is growing quickly in the U.S., Canada, South America, and Europe, and it entered China late last year.
  • More operating efficiencies. Management says it is improving its long-troubled relationships with key GM suppliers. It hopes this will both cut GM's costs and help the company get dibs on suppliers' latest innovations. Mark Reuss, the company's global product chief, is also working on a complex plan to sharply increase the number of parts shared "under the skin" among GM's vehicles. That should reduce engineering costs, improve GM's economies of scale still further, and improve overall quality in the next several years.

So why should we believe this? Because the plan is already starting to work -- and it builds on earlier successes from Barra and her team.

Barra and her team have already made huge progress
Talk is cheap, of course, and the company's long track record of financial ineptitude means it would be easy to dismiss Barra's plan as just another round of good intentions and hot air from a GM CEO.

But I think things are different this time. I think they are different because GM has already made huge progress since emerging from bankruptcy in 2009 -- and the key executives who drove that progress are now leading the company.

In 2011, when she was GM's global product chief, Barra led a sweeping overhaul of GM's expensive, slow, and inefficient product-development process. How did that work out? GM has saved a $1 billion a year and its product quality now rivals Toyota's.

That fact comes as a surprise to many people. The average American hasn't quite caught on to this story yet. But some big-name investors have, and the good news is that there's plenty of upside left.

General Motors' financial controls and discipline have arguably taken even bigger leaps forward than its products. Chief Financial Officer Chuck Stevens oversees much-improved systems that can track profitability in ways that GM leaders a decade ago could only guess at -- and he has top leadership's support for a level of financial discipline that was unheard of at the General for most of the last half-century.

Much of the credit for those improvements goes to Stevens' predecessor, Dan Ammann, who is now GM's president. Like Barra (and Reuss, who drove GM's turnaround in North America and was rewarded with Barra's old job), his success at changing GM for the better earned him a big promotion.

Main Street hasn't caught on, but Wall Street is taking note
Every time I write about GM, I hear from readers whose view of GM is stuck in 2009. They rehash GM's old failures, and admittedly there is certainly plenty to talk about. (I know, I owned some bad old GM products.)

But GM has come a long way since then. Its U.S. sales figures don't really show it yet, but the quality and competitiveness of its products has taken a giant leap forward from just five or six years ago. And its financial discipline and savvy has progressed even further.

Wall Street has caught on to these changes, even if Main Street hasn't. Goldman Sachs just released a list of the 50 stocks that appear most frequently among the top 10 holdings of "fundamentally driven" hedge funds (active stock pickers, in other words). Only one automaker made the list: GM, in 18thplace.

The hedge-fund crowd is not alone in catching on to the good story unfolding at GM. Warren Buffet's Berkshire Hathawayhas owned a sizable stake in the automaker for a while now.

But I wasn't convinced to buy GM stock because Wall Street wizards were buying. I was convinced because I saw the changes unfolding, I knew they were changes that GM had needed to make for decades, and I saw the possibility that this long-slumbering giant might finally start to realize its massive potential.

I think the hedge-fund folks (and Messrs. Buffett and Munger) have been seeing the same things.

The stock isn't as cheap as it was, but it's still reasonably priced -- and it pays a pretty good dividend. I think investors who buy here are likely to be very happy with that decision six or seven years from now. I'm not selling.

The article General Motors Company: Is This Stock a Buy? originally appeared on Fool.com.

John Rosevear owns shares of General Motors. The Motley Fool recommends Berkshire Hathaway, BMW, and General Motors. The Motley Fool owns shares of Berkshire Hathaway. 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.