Mr. Market apparently wasn't impressed with General Motors' (NYSE:GM) first-quarter earnings report. While earnings rose significantly year over year and GM North America had a record pre-tax profit, the automaker's adjusted earnings per share of $0.86 missed the average analyst estimate of $0.97.
Despite this minor disappointment, GM shares appear to be significantly undervalued. In fact, GM stock trades for just seven times forward earnings, making it one of the cheapest large-cap stocks out there. As long as General Motors continues to make progress on the strategic plans it laid out last fall, the stock is likely to be a long-term winner.
GM earnings miss the mark
In the first quarter, GM posted an adjusted profit before interest and taxes (or EBIT-adjusted) of $2.1 billion, primarily due to its strong EBIT-adjusted $2.2 billion profit in North America. Outside the U.S., GM's solid profit of roughly $500 million in China offset losses in its other foreign markets.
However, many investors were expecting even better things from General Motors last quarter, and the stock dropped from more than $37 to roughly $35 in the week following the earnings report.
Domestic trends remain solid
In North America, GM is benefiting from strong demand for its higher-margin pickups, SUVs, and crossovers. Through April, its 2015 U.S. sales of full-size pickups and large SUVS are up double-digits. Sales of the highly profitable Cadillac Escalade -- which has a starting MSRP of $72,970 -- have more than doubled year over year.
General Motors estimated that "mix" represented a $500 million tailwind in the first quarter. This helped GM achieve an 8.8% EBIT margin in North America, a first-quarter record.
But the company's North American margins would have been even better but for a roughly $400 million pricing headwind due to unprofitable sales of older-model vehicles at auction. Chief Financial Officer Chuck Stevens explained that GM had prioritized retail sales over fleet sales when doing recall work in 2014. This left it with outdated fleet inventory that had lost value over the past year.
Fortunately, that headwind is expected to dissipate in the second quarter and be negligible thereafter. Meanwhile, GM expects new and updated models including the 2016 Chevy Malibu to improve its pricing dynamics.
Another good omen for GM's profitability at home is that its retail sales in North America rose 6% last quarter, but wholesales -- which GM books as revenue -- rose only 2.7%. At the end of April, GM's U.S. inventory equaled 72 days of supply, down from 85 days a year earlier. This is allowing GM to reduce incentives and could justify higher production for the rest of 2015.
Fixing foreign operations and building up GM Financial
General Motors is well positioned to hit its goal of a 10% EBIT margin next year. Thus, management can focus on improving the rest of the company's operations.
In the past few months, GM has announced plans to quickly wind down loss-making production in Russia and Indonesia. It is also downsizing in Thailand and will stop local production in Australia in 2017. Just last week, the company announced that it will likely cease production in inflation-wracked Venezuela by July.
All of these moves represent decisive actions to improve profitability in markets that have been undermining GM's earnings power in recent years. The automaker should begin to reap the benefit of these actions later this year, with further improvements likely in 2016 and 2017. (New product introductions should also bolster its turnaround in international markets.)
Finally, the company is investing heavily in its GM Financial unit, which in the past few months has become the exclusive provider of subsidized lease financing for all of GM's brands in the U.S. As GM Financial grows over the next few years, it should become an important profit center for the company and boost the General's market share.
General Motors is on the right track to improve its performance in 2015 and beyond. Mr. Market appears to be severely discounting that possibility, providing a nice margin of safety for investors. Furthermore, GM has a generous forward dividend yield of more than 4%. This will keep investors satisfied while they wait for GM's stock price to catch up with its improving financial performance.