Introduction
General Motors, popularly known as GM, is one the largest automobile companies in the world. Founded in 1908 in Flint, Michigan, the company is currently headquartered in Detroit, Michigan. GM occupied the number one position in the automobile industry for 77 consecutive years from 1931 to 2007 ("General Motors Company and Subsidiaries" 2015). Currently, it is the 3rd largest automaker in the world. In 2009, due to operational inefficiencies, slowness in the automobile market in the USA and huge overhead costs, GM filed bankruptcy. However, it restored its operation within a year and came back to profitability within 2 years. Operating in more than 120 countries across the world, GM, apart from automobile divisions, also earns substantial amount of revenues from the financial division ("General Motors Company and Subsidiaries" 2015). GM’s story was more of a fairytale in the last 100 years. However, in the last 10 years, the company has struggled to increase its revenue and generate a profit and faced a cash crunch. Even after its tumultuous financial performance in 2009, the company continues to generate a huge interest in the financial community. This paper will discuss the current financial situation of GM, analyze different financial ratios and stock performance, and do a valuation of the firm from the perspective of an external investor.
Company Leadership
Currently, Mary Barra, who succeeded Daniel Akerson, is the Chief Executive Officer (CEO) of GM from 2014. She has been with GM for over 35 years and has witnessed many ups and downs in the economy and GM’s performance over the years ("General Motors Company and Subsidiaries" 2015). She knows the operational model of GM and nurtures a clear vision for the future. Daniel Akerson, the former CEO and the current Chairman of GM, has a huge industry experience in the US Navy, Nextel, Carlyle Group, and XO Communication ("General Motors Company and Subsidiaries" 2015). In 2010, Daniel Akerson became the CEO of GM and from 2014 onwards, he assumed the role of Chairman. During his tenure as a CEO, GM successfully came out of the phase of bankruptcy. Tim Solso, another Chairman of GM, is also an old employee of the company ("General Motors Company and Subsidiaries" 2015). From his experience of past GM operational efficiencies, he adds to the value of the organization. These three people play an important role in contributing to the value of the top management. While Tim and Mary understand the pulse of GM, Daniel provides meaningful insight into the company from his experience of external environmental of the automobile market.
Financial Statement Analysis
GM presently holds a market share of close to 19% in US market. Automobile is GMs largest division. However, in recent years GM Financial has become a large contributor in the revenue. In 2014, GM Financial contributed $4.8 billion as revenue. GM has seen relatively stagnant growth and modest profitability in recent years. However, taking into consideration the company’s loss of $21 billion in 2009, GM has done exceedingly well in posting positive profit in the last 5 years ("General Motors Co.", 2015). The income statement, balance sheet, and cash flow statement are provided in the Appendix of this paper. Only a few key indicators will be discussed in the paper.
It can be seen from the above revenue growth graph that the company faced a huge decline in revenue post subprime recession and had to file bankruptcy in 2009. This happened owing to two primary reasons. Over the years, GM has provided generous retirement packages to its employees to such an extent that the employee benefit burden went as high as $16 billion in 2008 ("General Motors Co.", 2015). GM was unable to bear with its overhead costs. The condition further worsened when the subprime recession took place in 2008. The sales of GM plummeted in several categories, which reduced its revenue and cast a huge pressure on its working capital. Furthermore, in 2009, GM was one of the worst in terms of operational efficiency among all the automobile companies. The outcome was a loss of $21 billion and subsequent filing of Chapter 11 (bankruptcy) ("General Motors Company and Subsidiaries" 2015). In 2010, with the help of the government, the company restarted its operation and offered one of the largest Initial Public Offerings (IPOs) in the history. Since then, GM has concentrated on reducing its overhead costs significantly. It has renegotiated the benefit packages of workers with the United States Auto Workers (UAW) that reduced its employee benefit burden from $16 billion to less than $4 billion per year ("General Motors Co.", 2015). GM also consolidated its operation after 2009 and stopped several brands such as Saturn, Pontiac and Hummer, which were making losses at that time. The company only focuses now on a few brands and tries to achieve greater operational efficiency and margin. Since 2010, GM was also able to increase its revenue back to its pre-bankruptcy level. Although the company is unable to grow in the last 3 years, but that problem is often attributed to reorganization and restructuring ("General Motors Company and Subsidiaries" 2015). The revenue forecast for the company remains positive.
After the bankruptcy of GM in 2009, the company made huge changes in the subsequent years to come back to profitability. Apart from taking measures to reduce overhead costs, the company also identified and shut down old plants. It retrenched a lot of employees. These cost-cutting measures helped improve the profitability of the company. Also, to compensate for the decreasing revenue in the US market, GM started aggressively expanding into high growth markets such as India, China, South Africa, Brazil, and Russia ("General Motors Company and Subsidiaries" 2015). In the above graph, it can be seen that the company came back to profitability from 2010 financial year onwards. Its profitability has reduced in the last 2 years due to a huge recall of old GM vehicles with faulty ignition switches that have cost the company a loss of $8 billion already and may cost a loss of additional $10 billion in the coming years ("General Motors Co.", 2015).
As expected that during bankruptcy, the working capital situation for GM was poor because of poor cash situation, GM was unable to pay its debtors and had to file bankruptcy subsequently. Since then the company has improved its working capital policy by renegotiating favorable credit terms with its suppliers and dealers ("General Motors Company and Subsidiaries" 2015). This has generated a lot of free cash from the operation as the cost burden was passed on to the suppliers and dealers. The working capital situation has improved significantly and currently, GM has a healthy working capital of about $17 billion.
Like working capital, free cash flow was also a problem for GM. The favorable credit terms not only helped the working capital situation, but also improved the overall cash situation. The company also took a short term loan in 2010 to improve its cash flow situation. Since then, GM succeeded in keeping the free cash flow situation always positive. However, the free cash flow for the company is not significantly high compared to its cost of goods sold. Therefore, GM should take further actions to ameliorate its working capital and free cash flow.
In 2009, account receivable for GM was 8.7% of its total assets. However, since then, the company has successfully increased its account receivable to 15% mainly by renegotiating its credit terms with the dealers. Before 2008, the credit term between GM dealer and GM was less than 45 days. GM increased it to 60 days for exclusive dealers and 75 days to non-exclusive dealers. The company’s inventory was 14% of its total assets ("General Motors Company and Subsidiaries" 2015). This indicates that a huge amount of working capital and cash were locked as inventory and GM was unable to rotate this cash to improve its operational efficiency. Since then, GM has improved upon its IT operations and forecasting process and aligned its production scheduling with the forecast. GM has also terminated the production of slow-moving brands such as Hummer and Saturn. All these initiatives helped the organization achieve an inventory that now locks up less than 8% of the total assets ("General Motors Company and Subsidiaries" 2015).
Financial Ratio Analysis
Liquidity Ratios
Liquidity ratio indicates a company’s ability to pay back its liabilities and invest in different instruments. Current ratio and acid test ratio are the two most common ratios used in measuring the liquidity situation of a company. Current ratio is calculated as the current asset/current liability. Current assets of a company consist of cash, short term investment, account receivable and inventory, whereas current liability consists of short term debt, tax payable, and accrued liabilities (Rodgers 2008). The current ratio should always be greater than one. The current ratio greater than one means that the company is able to pay all its short term dues using its short term sources of funds. The value less than one indicates the company’s inability to pay on time. In 2008, the current assets for GM were 48.62%, whereas the current liability was 83.05% ("General Motors Company and Subsidiaries" 2015). Therefore, the current ratio is
= 48.62/83.05 = 0.56
This current ratio is way below the required level of one. In 2014, the current assets for the company were 47.09%, but GM was able to reduce its current liability to 36.98%. Therefore, the current ratio for GM in 2014 is
= 47.09/36.98 = 1.27
This current ratio is above 1.0, which shows that the liquidity situation of the company has improved significantly. Similarly, acid test ratio can be calculated from the balance sheet. Acid test ratio is more rigorous measure of liquidity. It measures the company’s ability to repay the short term debts using its cash and short term investments without liquidating the inventory (Rodgers 2008). Using the figures from the balance sheet, it appears that the acid test ratio for GM in 2014 was =
Cash and short term investment/ current liabilities = 30.27/ 36.98 = 0.73
This above acid test ratio shows that GM is unable to pay its short term debt fully using its short term sources of fund excluding inventory. This is an area in need of improvement else GM may encounter cash crunch again in the coming days.
Average collection period and accounts receivable turnover also give good indication about a company’s liquidity situation. The higher the average collection period, the worse is the company’s liquidity situations. The average collection period and accounts receivable turnover depend on credit sales (Rodgers 2008). However, GM’s annual statement does not give an indication of what percentage of products is sold by the company as credit sales. Therefore, it is not possible to calculate these ratios.
Inventory turnover ratio is another ratio indicative of a company’s liquidity. A large inventory turnover indicates a lot of capital locked as inventory. Inventory turnover is calculated as the cost of goods sold/ average inventory. The cost of goods sold for the company in 2014 was $91.14 billion, whereas the average inventory for the same year was $13.6 billion ("General Motors Company and Subsidiaries" 2015). Therefore, the inventory turnover ratio for the company is 6.99 days, which is a fairly low value and it shows that GM is able to rotate its working capital significantly well and that its capital is not trapped in inventory.
Profitability Ratios
Profitability Ratios are measured in various ways. The most common profitability ratios are gross profit margin, net profit margin, and operating profit margin. These are often expressed as a percentage of revenue. However, from investors’ perspective, more important ratios are return on assets (ROA), operating profit margin, and the total asset turnover ratio (Rodgers 2008). Operating return on assets are calculated as
Total operating profit/ total assets employed
For GM, in 2014, the operating profit was $1.53 billion, whereas total assets were about $91 billion ("General Motors Company and Subsidiaries" 2015). Therefore, the total return on assets =
1.53/91 = 2.03
Therefore, the total ROA is about 2%, which is much below the industry average of 4.5%. GM still has a huge scope of improvement in this area.
The operating profit margin is expressed as a percentage of revenue. In 2014, the operating profit for GM was $1.5 billion and the revenue was $154 billion ("General Motors Company and Subsidiaries" 2015). Therefore, the operating profit margin =
1.5/154= 1
Therefore, the operating profit margin for GM is only 1%. This is also way below the industry average operating margin of 5%. However, the 2014 figure of GM is not representative of its actual operating margin as the company paid a huge amount for litigation settlement in 2014 for ignition switch faults. The company’s operating margin hovers about 3.5%, which is still below the industry average.
The total asset turnover ratio shows how much the company is able to roll its assets in the current year. The higher the turnover ratio, the better it is for the company as this indicates that GM is able to use the same asset multiple times for revenue generation. The total asset turnover ratio for GM is = Revenue/Total Assets = $154 billion / $177 billion = 0.91 for the present year, which is not impressive enough as it is below the industry average.
Financing Decisions
The financing decisions from an investor’s perspective depend on the capital structure of the company. The higher the debt ratio for a company, the riskier it is for the investor to invest in such company, because in the case of a default, the investor may lose a substantial percentage of its investment (Rodgers 2008). Therefore, debt ratio gives a good indication for the investors about financing decisions. Debt ratio is calculated as =
Total debt/ Total Assets
The total debt for GM is calculated as =
Total short term debt + total long term debt
Taking the figures from 2014 balance sheet, the debt ratio for GM comes to = Total debt / Total Assets = $141 billion/ $177 = 0.8. In 2009, the debt ratio for GM was 1.9 ("General Motors Company and Subsidiaries" 2015). However, through debt restructuring and renegotiating with the union and financiers, GM successfully reduced its debt burden to 0.8. Presently, the debt burden of the company is better than the industry average.
Return on Equity
Return on Equity (ROE) shows the amount the shareholders are getting back from their investment in GM shares through dividend payout and stock growth. ROE is calculated as Net Income/ Shareholders Equity. For 2014, ROE for GM can be calculated as
ROE = Net Income/ Shareholders Equity = $4.08 billion/ $36.98 = 11% ("General Motors Company and Subsidiaries" 2015)
Market Value Ratios
Market Value Ratios are indicative of how pricey GM’s stocks are. The two major indicators of Market Value Ratios are price earnings ratio and price book value ratio. As the name indicates, the price earnings ratio is calculated as =
Price of the stock/ earnings per share
In December, 2014, the price of GM stock was $31.4, whereas the earnings per share for 2014 were $1.65 ("General Motors Company and Subsidiaries" 2015). Therefore, price earnings ratio is 19.03. This means that the stocks are traded at a value 19 times more than the present earnings of the company. This can mean two things. Firstly, investors may assume that GM’s performance will significantly improve in the coming years. Secondly, it may also indicate that price of GM stocks is grossly overvalued.
Price book value ratio (P/B ratio) = market value of share / book value of share. Market value of share for GM is $31.75 and book value is $22.17. Therefore, the P/B ratio is = 31.75/22.17= 1.43. This means that the market is overvaluing the stock which is not uncommon. However, in this case investors has a risk of losing money in case of bankruptcy.
Industry Analysis
The table above shows the comparison between GM and other industry leaders and industry average. The salient points to be noted from the above table include poor revenue growth of GM compared to industry and Toyota and poor gross margin (11% for GM compared to 20% for the industry). It has been discussed earlier that the operating margin of the company is also about 3% compared to 5% of the industry. Toyota has a high operating margin of 10%, which is unmatched by any of the big players in the automobile market.
Stock Performance
Figure: Stock Movement of GM (“General Motors Company (GM)", 2015)
GM stock has done poorly in last five years. Especially after the IPO, GM stock tanked to below $20 level. Since then the stock was to recover some ground but still trading at a price below its IPO price. GM regularly pays a dividend of 0.3 cents per book value of share, which is below the industry average of 0.38 ("General Motors Company and Subsidiaries" 2015). Recently, the company has increased its dividend payout from 0.3 to 0.36. Still, the dividend payout is less than the industry average. In addition to that, the stock growth of the company is almost negligible. In the last 2 years, GM’s stock has grown by less than 10%, which is one of the lowest in the automobile industry.
We can calculate the value of GM stock using many different techniques. We will use the earnings method for the calculation. This year’s (2014) earnings per share (E) for GM is = $ 1.65 and assuming growth rate of earning is 3% (G). Number of years earnings will grow is = 15. If desired rate of return by the investors is 7.5% then the price of the stock is the present value of all the stock returns from future years which is calculated in the below table
The price comes out to be 29.46 and the actual value is 31.75 which is slightly higher than the calculated value. Therefore, it is not a good time to buy the stock unless the investor strongly believes that GM will grow at a rate more than 3% YOY for next 15 years.
Conclusion and Recommendation for Investors
As seen from the above discussion, GM has recovered well from its bankruptcy in 2009. The company has come back to profitability within 2 years. It has also improved the key performance parameters, including inventory, account receivable, and price earnings ratio. However, from the financial ratio analysis, it is seen that the company has still issues in the areas of liquidity. The acid test ratio is well below 1, which indicates that the company may face credit crunch any time in the future. The debt ratio of GM shows its healthy debt to equity percentage and its ability to avail more funds from the market, if required, but its profitability ratios and return on equity are well below the industry average. The operating margin of GM is only 3%, which is below the industry average of 5% and well below the industry leader Toyota, which has an operating margin of 10%.
Although the overall revenue and profit figures may appear promising and give good indication about GM’s future, its liquidity ratios, profitability ratios, and market value ratios are well below the industry average. In fact, its liquidity ratios still are at still dangerous level. Any sluggishness in the market and even a small oversight by the management can wreak havoc in the organization. Therefore, my suggestion to the investors will be to wait and watch GM’s stock till GM improves its liquidity situation and operating margin further. If the company can successfully achieve both in the coming years and can return back to moderate growth path, then it may become a lucrative stock for buyers. Unfortunately, GM’s stock is not ‘buy’ now.
Work Cited
"2014 GM Annual Report”. General Motors Company. 2014. Web. 13 Jul 2015 <http://www.gm.com/content/dam/gmcom/COMPANY/Investors/Stockholder_Information/PDFs/2014_GM_Annual_Report.pdf>
"General Motors Company and Subsidiaries". General Motors Company. 2015. Web. 13 Jul 2015 <http://www.gm.com/content/dam/gmcom/COMPANY/Investors/Corporate_Governance/PDFs/InvestorContactsPDFs/10-Q.pdf>
"General Motors Co." Morningstar. 2015. Web. 13 Jul 2015 <http://financials.morningstar.com/ratios/r.html?t=GM>
"General Motors Company (GM)". Yahoo Finance. 2015. Web. 13 Jul 2015 <http://finance.yahoo.com/echarts?s=GM+Interactive#{"range":"5y","allowChartStacking":true}>
Rodgers, Paul. Financial Analysis. Oxford: CIMA, 2008. Print.
Robinson, Thomas R. International Financial Statement Analysis. Hoboken, N.J.: John Wiley & Sons, 2009. Print.
Appendices
Income Statement
Source (“2014 GM Annual Report” 2014)
Balance Sheet
Source (“2014 GM Annual Report” 2014)
Cash Flow Statement
Source (“2014 GM Annual Report” 2014)
