Shares of General Motors (NYSE:GM) surged more than 10% this week after the largest U.S. automaker reported better than expected January sales in the U.S. and posted a Q4 profit that crushed analyst estimates.
That said, GM stock traded for more than $40 in early 2014 before a massive wave of recalls caused investors to flee the stock. Luckily, GM doesn't seem to have suffered much permanent damage from its recall woes, and the company is on track for strong earnings growth. This should help GM stock rebound and rise well beyond $40 in the next year or two. Let's take a deeper look at the some of the factors expected to drive this future growth.
North America drives profit growth
GM reported adjusted EPS of $1.19 for Q4, which easily exceeded the average analyst estimate of $0.83. Much of the earnings upside came from the North America region, which still produces the vast majority of GM's global earnings.
In Q4, EBIT-adjusted (GM's preferred measure of pretax income) rose about 17% at GM North America, reaching $2.21 billion. This earnings growth was driven by a combination of mix and pricing.
In this regard, GM is benefiting in a big way from the recent drop in gas prices. This has stimulated strong demand for highly profitable full-size pickups and large SUVs. In the full-size truck market, GM gained almost 5 points of retail market share last quarter, thanks to severe supply constraints at top rival Ford.
Large SUVs have also been a point of strength for GM. In fact, the company now controls more than 75% of the U.S. market for large SUVs. GM picked a great time to launch new models in early 2014. With new products in the segment, GM is earning higher margins on each sale just as demand is rising.
Profit growth will take off in 2015
This strong profit momentum should continue in 2015, lifting GM stock further. GM's solid Q4 profit growth in North America came despite its wholesale volume dropping from 863,000 to 849,000 vehicles.
This reduction in wholesales was not the result of weak demand. Rather, in Q4 2013, GM North America's retail sales trailed wholesales by 79,000 units, meaning that dealers were accumulating inventory. By contrast, retail sales exceeded wholesales by 5,000 units last quarter.
Looking at the U.S. specifically, GM's inventory totaled 732,470 vehicles at the end of last month. That compares to inventory of 780,140 vehicles at the end of January 2014. This indicates that GM is better matching production with demand this year. Indeed, the company faced a significant inventory glut at this time last year.
In total, GM produced significantly fewer vehicles than it sold in North America during 2014, correcting for some overproduction during 2013. In 2015, GM will need to ramp up production to meet higher demand. Its leaner inventory position should also drive margin expansion this year. The resulting profit growth will be a meaningful catalyst for GM stock.
Managing headwinds around the world
Elsewhere in the world, GM faces headwinds from currency fluctuations, sluggish economic growth, and overcapacity in multiple regions. Nevertheless, GM expects to post year-over-year earnings growth in every region in 2015.
In Europe, GM closed its plant in Bochum in December. This will help address overcapacity in the region. GM has also faced significant restructuring costs in Europe in recent years due to that plant closure, which will not recur in 2015. As a result, it should get much closer to breakeven in Europe this year.
In China, GM continues to post steady earnings growth. This will offset weakness and high restructuring charges elsewhere in its international operations segment. Lastly, GM has already shown a positive trend in South America, where it posted profit growth in Q4 after losing money for most of the year.
Despite GM's forecast for strong earnings growth in 2015 and 2016, GM stock currently trades for just over eight times projected 2015 earnings. By contrast, Ford stock trades for about 10 times earnings. This implies that investors are very skeptical of GM's earnings targets.
If GM can capitalize on its favorable market position in North America this year while also producing better earnings in each of its other regions, this should help the company gain much more credibility with investors.
As a result, GM stock is likely to close the valuation gap with Ford in the next year or two. This could lift it well beyond its previous high -- perhaps as far as $50. In the meantime, investors can enjoy GM stock's hefty dividend yield of nearly 4%.