Can General Motors Warrants Turbocharge Your Portfolio?

Investors seeking potential high-octane profits via General Motors (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 warrants were issued November 2010 in conjunction with its emergence from bankruptcy.

Why invest in GM at all?
Before considering General Motors 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 (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 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 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 did not require federal assistance during the financial crisis. Since the crisis, Ford 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 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 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 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 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.

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.

Two Other Automakers Set to Dominate
There's good reason to believe that the most successful investors over the next few decades will be those with exposure to China's massive and growing population of domestic consumers. And there are few things that these consumers are likely to purchase with more enthusiasm than cars and trucks. In this brand-new free report, our analysts get out in front of this trend by identifying two automakers that are poised to surge along with China's middle class. If you want to be among the smart investors who get rich from this growing trend, then you'd be well advised to instantly download our free report on the topic by clicking here now.


Read/Post Comments (4) | Recommend This Article (0)

Comments from our Foolish Readers

Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

Add your comment.

Sponsored Links

Leaked: Apple's Next Smart Device
(Warning, it may shock you)
The secret is out... experts are predicting 458 million of these types of devices will be sold per year. 1 hyper-growth company stands to rake in maximum profit - and it's NOT Apple. Show me Apple's new smart gizmo!

DocumentId: 2633133, ~/Articles/ArticleHandler.aspx, 11/21/2014 7:11:32 PM

Report This Comment

Use this area to report a comment that you believe is in violation of the community guidelines. Our team will review the entry and take any appropriate action.

Sending report...


Advertisement