Over the past few years, there was a case to be made that General Electric Company (NYSE:GE) and General Motors Company (NYSE:GM) shared a lot more than just the similar names. Both paid relatively high dividend yields, and both had some challenges with their businesses, but management seemed to be making progress to point them in the right direction.
Yeah, about that.
Frankly, GE has turned that thesis on its head, as the industrial giant struggles under a big pile of debt and weak results across several operating units that have not only stalled its turnaround but convinced many investors that its future will be as a shell of its former self. GM, on the other hand, continues to plug away, even as the automotive cycle trends downward.
So GM's the clear winner, right? Not so fast; it really depends on what you're looking for. If it's a lower-risk investment trading at a solid valuation that's also a source of predictable income, GM is certainly the better buy. GE, on the other hand, could have a much higher upside if new CEO Lawrence Culp finally proves to be the leader to turn things around.
Let's take a closer look at the case for each as the better buy.
GM: A value stock set up for any economic condition
The auto business is cyclical, as any consumer-driven industry is. Demand for new cars can swing wildly from one quarter to the next, as interest rates, economic growth, wages, and even oil prices can impact how many people line up to buy a new car.
Of course, GM investors have paid the price for not understanding this in the past; or maybe more accurately, they paid the price of GM's former management not positioning the company to ride out those ups and downs. After all, some $82 billion in assets were wiped out when it went bankrupt in 2009. That makes it the fourth-biggest bankruptcy in U.S. history to date.
Yet today, GM is well capitalized, and thanks to its renegotiated deal with the unions that represent its labor force, the company's operating structure is far more competitive with those of other automakers. This has allowed GM to continue generating both a GAAP profit and substantial operating cash flows over the past couple of years, even as the number of cars it has sold and its revenues have declined:
In the past, the kind of revenue decline GM has seen recently would have been enough to send its cash flows and earnings into the red. At the same time, its balance sheet is set up to support the business -- and the dividend -- even if conditions were to worsen. GM has more than $18 billion in cash on its balance sheet, a significant margin of safety for this capital-intensive, cyclical industry.
Furthermore, GM shares remain cheap. Its earnings-based valuation has skyrocketed over the past year as its profits have fallen. (It even reported a big GAAP loss related to some restructuring earlier this year, which explains the big gap in the PE ratio in the chart below.) But the earnings decline shouldn't be a surprise based on the cyclical nature of auto sales and the impact this has on capital-intensive automakers. But from a cash flow perspective, which I think is a better measure of GM today, it's cheap.
It's also cheap when using forward earnings estimates, which are based on non-GAAP earnings, which are typically adjusted to exclude nonrecurring and some other items.
But cash is king, and at 3.2 times trailing cash from operations, GM makes for a solid value. Considering it also pays a dependable dividend yielding 4.2% at recent prices, GM should prove to make investors money over the long term.
GE is betting that a new CEO can finally turn things around
GE investors have been counting on a big turnaround for the better part of a decade now. In the aftermath of the global financial crisis, GE was saddled with billions in consumer debt and had morphed so much over the 20 prior years that it looked more like a consumer lending bank than an industrial manufacturer.
Unfortunately, the process of selling off many of those financial assets did much less to improve the company's prospects or strengthen its balance sheet than many hoped. To the contrary, there's a strong case to be made that GE's biggest mistake was selling off its consumer lending assets at or very near the bottom, generating far less in proceeds than it would have simply by letting market conditions continue to improve and multiples return to normal levels as consumer spending and credit improved.
Of course, hindsight is 20/20, as they say, and here we are today, with a GE that's stripped of many of its former cash-cow financial assets but still saddled with a lot of debt and other financial obligations. It has also merged or sold off some of its best assets with other companies, including one of its oldest businesses, locomotives, and its oil and gas business, so far, to mixed results.
The bottom line is, though GE has reduced a lot of its debt and pension obligations, even more shareholder value has been eroded over the past five years:
The upside? Larry Culp isn't messing around, and he plans to get even more aggressive to pay off debt. This is a key reason behind the decision to all but eliminate the dividend, which now is only a penny per quarter per share. This will free up about $1 billion each quarter in cash.
But with $115 billion in long-term debt, the extra $4 billion annualized will only help so much; GE will need to improve its cash flows and will also continue to sell and spin off assets to address what Culp says is management's highest priority right now: reducing GE's leverage.
Here's the rub: GE is currently priced for disaster, as my fool.com colleague Adam Levine-Weinberg put it recently. And it probably shouldn't be, because it's still a solidly cash-flow-positive business with a lot of great assets. As Adam described, the per-share value of its locomotive spinoff and its healthcare business, which management has said it could spin off, could be worth more than $5 per share.
GE shares trade for $8.19 as I write this, implying a substantial disconnect between GE's asset value and the market's expectations.
Of course, it's unlikely that the market will apply full value to GE so long as its operations continue to struggle to deliver the kinds of earnings they are expected to, particularly if the balance sheet remains so leveraged.
But if you expect Culp to -- finally -- be the CEO to unlock the value of GE's assets and turn the balance sheet back into a strength, then GE, with its massive upside simply based on its asset value, is the better buy.