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General Motors Upgraded: What You Need to Know

By Rich Smith – Oct 3, 2018 at 12:42PM

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Here's why Wolfe Research likes GM stock.

Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...

The news broke like a thunderclap over Wall Street: Honda Motor Co. (HMC 1.03%) will invest $750 million in General Motors' (GM 1.92%) autonomous vehicle (AV) division, Cruise, and Honda will invest a further "$2 billion over 12 years" in order "to fund and develop a purpose-built autonomous vehicle for Cruise that can serve a wide variety of use cases and be manufactured at high volume for global deployment."

At $2.75 billion total, that's four times the roughly $600 million that GM spent to acquire all of Cruise just a couple of years ago, and more than the $2.25 billion that Softbank agreed to invest in Cruise just a few months ago. Yet for its investment, Honda will receive only about a 5.7% stake in Cruise -- about a quarter of what Softbank got for its smaller investment in May. In its statement on the investment, GM revealed that with Honda's investment factored into the mix, "[T]his transaction brings the post-money valuation of Cruise to $14.6 billion."

So as it turns out, GM got itself a steal of a deal when it bought Cruise in 2016. It's also got itself a brand-new upgrade.

Close-up of a car's tire in motion next to a yellow line on the road

Image source: Getty Images.

Upgrading General Motors

Analysts at Wolfe Research have upgraded General Motors stock to outperform, as we learned this morning from (subscription required). But here's the thing: Although Wolfe made General Motor's autonomous vehicle division a central part of its buy thesis, according to SI, this upgrade came before the Honda investment was announced.

GM's "AV business" (that's Cruise) "is coming to forefront in 2019," argued Wolfe Research, in a prediction that proved prescient less than 24 hours later. And while we don't have any more details on this point of Wolfe's buy thesis, it appears to align with a similar upgrade that automotive specialist John Rosevear discussed back in July.

Back then, analysts at RBC Capital Markets were cited arguing that if General Motors uses Cruise to build out a "transportation network company" comprising electric cars driven by autonomous Cruise software (as GM intends to do next year), such a business might put as many as 800,000 new vehicles on the road by 2030. It might also generate $31.9 billion in revenue for Cruise, and generate pre-tax operating profit margin of 29% -- more than $9.25 billion a year. Assuming GM still owns about a 75% stake in Cruise at that time, this could mean as much as $6.9 billion in extra operating profit for GM.

To put that number in context, all of GM has earned operating profit of only a bit more than that -- $8 billion -- over the past 12 months.

Psst! GM still builds trucks

That prospect alone would probably be enough to entice investors. But as Wolfe notes, in addition to forging ahead with autonomous vehicles, GM is already "arguably one of the best managed Auto OEMs on the planet with a focus in inherently more profitable and higher return products and businesses."

Currently, GM is busy setting up a transition to production of "all-new" full-size pickups in the 2019 GMC Sierra and Chevy Silverado, and Wolfe believes that the costs associated with this transition have "weighted down" the company's valuation. (Trailing operating profits are, in fact, lower than GM has earned in any of the past five full fiscal years, according to data from S&P Global Market Intelligence.)

But as the transition progresses and evolves into sales, Wolfe seems confident that GM's profits will pick up the pace as well. Will they improve enough to return the company to the supra-7% operating profit margin it was earning in 2016 and 2017? Perhaps. But even with profits temporarily depressed, it's worth noting that GM's 5.6% operating profit margin outclasses Ford's 3.5% margin by more than 2 full percentage points.

What else investors need to know

Admittedly, General Motors stock looks somewhat risky today. In contrast to Ford, which remains profitable despite its lower operating profit margin, GM is currently reporting negative profits (and negative free cash flow). Viewed side by side, that seems to make Ford stock, with its 5.4 P/E ratio and its 7.9% dividend yield, look like the safer investment.

And yet, Honda is investing in GM's autonomous vehicle technology -- not Ford's -- which seems to suggest that GM may be holding the stronger hand in this contest.

One final wild card to consider is what Honda's alliance with GM means for Tesla and its Autopilot technology. Clearly, Model 3 production is ramping up, and the faster that happens, the quicker Autopilot could become the de facto standard in autonomous vehicle software. On the other hand, an alliance between GM and Honda, with their combined annual sales of 15 million cars a year, could upset that balance -- if they can bring their robot taxi idea to fruition fast enough.

Having an extra $2.75 billion in hand should go a long way toward making that happen.

Rich Smith has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends TSLA. The Motley Fool recommends F. The Motley Fool has a disclosure policy.

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