It's been a bad start to 2014 for General Motors (NYSE:GM), with shares down 10% since the beginning of the year. Bears suggest there is more downside ahead, while bulls continue to harp that the stock has a low valuation and solid dividend yield. I have been on the bearish to neutral side, simply because I do think there is more downside.
However, the market has clearly spoken. The stock price continues to float in the upper-$30 range and has been shaking off recent negative headlines regarding more recalls. This is usually a good sign. So without further ado, let's take a look at the good, the bad, and the ugly.
General Motors has some attractive qualities for investors to stay in the name. For starters, the stock trades with a low valuation, at just 7.8 times next year's earnings.
Of course, it's easy to argue that if the company continues to take more cost charges (which we'll discuss below), then the valuation may not be as attractive, since earnings will be lower.
GM also pays out a handsome dividend, with a yield of 3.3%. That's certainly one aspect of the business to like, especially for a company with big cash flows and a payout ratio of just 20%, according to Yahoo! Finance. In other words, it's highly unlikely the dividend will be suspended.
Management is another selling point. CEO Mary Barra took over less than one month before the ignition switch cover-up news broke in mid-February. Talk about a welcome party. She has handled the news -- which threw the company into a tailspin of PR nightmares -- quite well.
Her feelings toward the situation are obvious, and she appears to truly regret what has happened at the company, even if none of it happened under her watch. I think Barra is a good leader, and one that also cares about the customers' well-being, not just profit. Hopefully her management style will trickle down through the upper levels of management, all the way down to the assembly lines.
Finally, sales haven't suffered one bit. In fact, it's been the opposite. With the exception of February, each month since the ignition switch recall announcement has resulted in positive sales gains. In May, the automaker posted a sales increase of 13%! Obviously, consumers don't care about the recalls.
While there are good things going on at General Motors, it's not all roses and sunshine. In addition to the standard costs associated with building and distributing automobiles around the world, GM racked up $2 billion in first-quarter charges.
Most of that cost came from the $1.3 billion charge it took in relations to the company's skyrocketing amount of recalls. $400 million came in the form of currency swings in Venezuela -- Ford and countless other large U.S. corporations were also hit -- and $300 million came from restructuring costs.
While the cost is indeed lower this quarter, General Motors recently announced it is upping its original second-quarter charge of $400 million, to $700 million for the costs associated with the recalls. In the announcement, the automaker also recalled an additional 3.36 million cars, boosting its total to 20 million vehicles recalled globally this year.
This is unlikely to be the last recall from General Motors in 2014, and thus, there are likely to be more costs ahead. So far, the company has racked up $2 billion in recalls costs this year, including estimated costs for this quarter.
To put this figure in perspective, the company reported a net income of $3.8 billion for all of fiscal 2013.
General Motors was also hit with a rather large lawsuit. The claim, which is up to $10 billion, argues that customers' vehicles no longer have as strong of a resale value because of the onslaught of recalls. While $10 billion is a big number, I don't really think we'll see that sort of "justice" handed down to GM, if any. Only time will tell, but it's something investors should keep in mind.
It may not bother some investors, but I just find it hard to be a buyer of General Motors with the unknown land mines that inevitably lay ahead. There are two major unknown costs that are more than likely to hit General Motors.
The Department of Justice is almost certainly going to fine GM; the only question is, how much will it cost? Earlier this year, the DOJ fined Toyota Motors $1.2 billion for its cover-up of an unintended acceleration issue.
It's unclear whether the fine for General Motors will be less than, equivalent, or more than the fine handed down to Toyota Motors. Furthermore, Barra has indicated the company is working on some sort of victims' compensation plan.
Between the two "unidentified land mines," I would be surprised if the total cost was less than $2 billion.
Perhaps investors have priced that bad news in. After all, the stock no longer gets knocked down when the company announces more recalls or higher-cost charges for the quarter. That might be investors' way of saying, "Hey, no big deal. We know."
But I don't share the same mind-set. When there is more clarity on "the ugly," then I can start to take a look at General Motors on the long side. Or, if the stock declines to $30-$32, then I'll find it more attractively priced, given its upcoming and unknown costs.
Why $30-$32? That's just where I feel comfortable from a risk standpoint. In three years, will shares be higher from today's levels? Probably. But if the stock was to decline another 15% first, we Fools could find a much better place to invest our hard earned dollars -- such as Ford -- until General Motors looks more attractively price.
The valuation is attractive, but it can certainly become more attractive if the upcoming news is worse than expected or if there are any more recall costs.
Bret Kenwell owns shares of Ford. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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