General Motor's HQ in Detroit: Photo credit: General Motors.
I recently read a bearish article regarding General Motors (GM +1.57%) and the conclusions it presents compel me to remind everyone that you should always crack open a 10-K and dig deeper. My job today is to explain and debunk the first of three bearish author's arguments. I'll explain the following two arguments in later articles.
The bear's thesis
GM has simply been boosted by the rebound in auto sales based off the artificially low interest rates for auto loans. General Motors as a company, however, has only gone downhill: Its net income is declining, its margins are shrinking, and it's overloaded with subprime financed consumers.
Whoa, sounds nasty, right? Not so fast, there's much more to the story.
It begins by debunking the argument regarding a decline in net income and showing that sales, general, and administrative, or SGA, costs have surged even though the company hasn't improved profitability:
Graph by author. Information from General Motors SEC filings.
The first flaw is in judging General Motors' SGA expenses out of context. Most analysts won't look at the raw dollar amount spent on SGA; rather, they will judge it in comparison to overall revenue. Like most budgets, you set aside a percentage of your money for expenses. As you make more money, you can spend more on expenses, as long as the percentage remains relatively flat.
If you use that logic for GM's SGA expenses to overall revenue, you'll find the ratio does stay relatively flat. From 2009 to 2012 SGA of revenue was 11.6%, 8.6%, 8.1%, and 9.2%, consecutively, for an annual average of 9.4%. The increasing SGA expense isn't a red flag; it's a sign that General Motor's revenue has increased and has allowed a larger expense budget.
The bear's argument continues and notes that net income attributable to stockholders has only increased from $6.17 billion in 2010 to $6.18 billion last year. Even further, that net income has declined from $3.1 billion during the first six months of 2012 to $2.5 billion for the first half of 2013. While that's true, there's much more to the story.
What I noticed when while digging deeper is circled below:
Table by author. Information from General Motors SEC filings.
As General Motors exited its unique bankruptcy, it was essentially granted future tax benefits, which could be worth as much as $45 billion. Those "tax loss carry-forwards" enable GM not to pay taxes on as much as $45 billion in future profits -- inflating previous net income figures. Those tax benefits are now running out and GM is beginning to pay the taxes it rightfully should, which is dragging net income lower while the company itself is actually getting financially stronger.
General Motor's financial strengthening is even more apparent when you consider that its cost of sales increased roughly $10 billion from 2011 to 2012, while revenue only increased $2 billion -- yet General Motors was able to absorb those additional costs and even report an improving pre-tax income. Imagine how its bottom line will improve when revenues are boosted by redesigning, replacing, or refreshing 90% of its vehicle lineup -- the oldest in the auto industry -- by 2016.
Moreover, because of its unique situation, GM uses EBIT-adjusted (earnings before interest taxes) numbers in its quarterly presentations to give a more accurate look into the company's business operations. Looking at those EBIT-adjusted numbers for the same period in which the bearish argument shows a decline in net income reveals an improvement from $2.1 billion to $2.3 billion. Even better, GM's adjusted automotive free cash flow has improved from $1.7 billion to $2.6 billion. That more accurately reflects GM's improving business operations before tax credits and other factors are considered.
Bottom line
GM's financials are definitely improving, although it still remains years away from reaching net income margins like those of Ford (F +1.11%). The two rivals find themselves in very different positions in the same race. Ford is focusing on growing its top-line sales and revenues faster, as its bottom line is already efficient and profitable. GM, on the other hand, has strong top-line revenues and better market share globally, yet struggles to produce the profit that it should be able to, and as Ford does. Ultimately, GM still faces many issues but you can't merely cherry-pick ratios and numbers to formulate a biased bearish argument; you have to dig deeper when intending to make serious investing decisions.
If you haven't cracked open a 10-K filing and read through the numbers and explanations, then you should. You'll be very surprised how quickly you'll learn massive amounts of valuable information, much of which would have changed the ursine author's thesis. Stay tuned for more articles debunking the rest of the bear argument.
