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General Motors’s 23.8% return over the past six months has outpaced the S&P 500 by 13.4%, and its stock price has climbed to $58.68 per share. This performance may have investors wondering how to approach the situation.
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Despite the momentum, we’re sitting this one out for now. Here are three reasons why GM doesn’t excite us and a stock we’d rather own.
Revenue growth can be broken down into changes in price and volume (the number of units sold). While both are important, volume is the lifeblood of a successful Automobile Manufacturing company because there’s a ceiling to what customers will pay.
General Motors’s units sold came in at 974,000 in the latest quarter, and over the last two years, averaged 2.5% year-on-year growth. This performance was underwhelming and suggests it might have to lower prices or invest in product improvements to accelerate growth, factors that can hinder near-term profitability.
Free cash flow isn’t a prominently featured metric in company financials and earnings releases, but we think it’s telling because it accounts for all operating and capital expenses, making it tough to manipulate. Cash is king.
As you can see below, General Motors’s margin dropped by 7.9 percentage points over the last five years. It may have ticked higher more recently, but shareholders are likely hoping for its margin to at least revert to its historical level. If the longer-term trend returns, it could signal increasing investment needs and capital intensity. General Motors’s free cash flow margin for the trailing 12 months was 7.7%.
Debt is a tool that can boost company returns but presents risks if used irresponsibly. As long-term investors, we aim to avoid companies taking excessive advantage of this instrument because it could lead to insolvency.
General Motors’s $135.7 billion of debt exceeds the $29.34 billion of cash on its balance sheet. Furthermore, its 5× net-debt-to-EBITDA ratio (based on its EBITDA of $20.34 billion over the last 12 months) shows the company is overleveraged.
At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. General Motors could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.
