Dueling Fools

Dueling Fools

GM Tough
Bear Argument

By Richard McCaffery (TMF Gibson)
October 13, 1999

It's easy being the bear on a company that sells a commodity product, can't raise prices, faces a worldwide supply glut, and operates in an industry requiring enormous cash.

Not that I've got anything against GM. It has a great brand name, though I think its maze of vehicles -- i.e., Chevy Trucks, Pontiac, Buick, Oldsmobile, GMC, Cadillac, Chevrolet, and Saturn -- diminishes its identity.

And I love GM's DirectTV satellite television business, which brings the complete NBA season into my house eight months a year. Please don't tell me about its hidden value. Investors shouldn't buy into the world's largest industrial corporation to get a slice of Hughes Electronics (NYSE: GMH), which owns DirecTV. All they have to do is buy the tracking stock.

The bottom line is that GM is a cash burner in a low-margin business. These are the financial laws of gravity: Either compete in a high-margin business, or manage assets efficiently to yield a high return. Dell (Nasdaq: DELL) and Amazon.com (Nasdaq: AMZN) make a killing in low-margin businesses. Microsoft (Nasdaq: MSFT), the Bruce Jenner of stocks, has high margins and great asset management.

GM has neither.

Check out the company's most recent 10-K. GM's net margins (from continuing operations for just its automotive and electronics businesses) stood at 1.1% last year, compared to 2.5% in 1996. That means that in 1998 the company made a little more than a penny on every dollar of sales. By way of comparison, the average public company has profit margins in the 7% to 8% range, and Fools, a choosey bunch, look for companies with net margins in the 10% range.

Now, you could argue that 1998 shouldn't be used for comparison because of the 54-day strike at two GM component plants in Flint, Michigan. The work stoppage, which pretty much halted North American production, cost GM $2 billion in earnings. No question it skewed results for 1998, but how uncommon are strikes in the auto industry?

In Q2 1997, GM took a $490 million after-tax hit from an 84-day strike at a Pontiac, Michigan, truck assembly plant. In Q1 1996, GM took a $900 million after-tax hit because of a strike-related work stoppage. Investors should understand that strikes are part of business in the auto industry. As a long-term investor, I wouldn't consider them extraordinary items.

Move down to the company's balance sheet for a look at its asset management and remember that's the second key. Dell's margins are no good but the box maker's balance sheet sings.

Again we're looking only at its automotive and electronics unit. In 1998 GM generated $1.14 in sales for every dollar of assets employed, a 13% decline from $1.31 in 1997. This is low to begin with and moving in the wrong direction. Think about it: On a dollar-for-dollar basis, all that steel produced just $0.14 and $0.31, respectively, in sales. Without the financial leverage generated by productive assets or high margins, investors are at a huge disadvantage.

Now, this is an easy knock on a car manufacturer because it's such a capital-intensive industry. I'm not going to compare GM's sales/asset ratio with Dell, which needs little in the way of fixed assets. (Though investors should be thinking this way. We get to choose the businesses we're in, GM doesn't.)

Let's compare GM to Ford (NYSE: F), its Motor City competitor. In 1998 Ford generated $1.34 in sales per dollar of assets employed, compared to $1.44 in 1997. Ford comes out on top in both years, and this is with lower revenue than GM. Ford's numbers declined last year just like GM, largely because of the Asian Flu and other economic issues.

Still, Jacques Nasser, Ford's new president and chief executive, has lit a fire under the old tree by attracting new blood from throughout the auto industry, cutting through bureaucracy and pushing for more innovative designs. GM doesn't have the same buzz.

In short, investors should buy the best companies in the strongest industries and GM doesn't qualify on either count.

Move on to GM's cash flow statement. The company is nicely cash flow positive and its operating cash flow margin is higher than its net profit margin. But it burned almost as much cash in investing activities last year as it created from operations -- and last year was not unusual.

A big chunk of cash generated from car sales was put right back into property, plant, and equipment. In 1998 GM generated $9,349 million from operating activities and spent $9,339 million on property expenditures. The industry is a cash furnace.

Since I could be taken to task for not examining all of GM's divisions, let's take a quick look at the whole enchilada, which includes the company's more profitable financing and insurance operations. Skip 1998 to avoid the big strike year and go to 1997. Net profit: 3.5%, a solid improvement. Sales per dollar of assets employed: $0.77, worse than for just the automotive unit. Not much there to recommend.

Finally, turn away from the numbers and consider one of the most important classes of vehicles in the industry, the midlevel family car. Everyone knows the Toyota Camry, Ford Taurus, and Honda Accord. These cars are not as profitable for auto makers as trucks or luxury vehicles, but they're high-profile. What car does GM make in this class? I had to look it up. GM has the Chevrolet Malibu and Chevrolet Lumina, and I'm sure a few others. Can you picture either of these cars?

So what has the world's largest automotive company done to protect its turf in this critical segment, or to capture investors' imaginations? Fools can find better investments.

Next: The Bull Responds