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Mind the hype

18 August 2010 By Antony Currie

General Motors much anticipated initial public offering filing finally landed on Wednesday. But investors shouldn t get too caught up in the hype. Sure, the automaker looks in pretty decent shape thanks to last year s bankruptcy clean-up, and car sales are motoring away from last year s lows. But to repay U.S. taxpayers in full, GM needs to at least double its earnings.

That s assuming the carmaker is valued at the same earnings multiple as Ford Motor. Granted, GM and its bankers could argue that it has advantages over its cross-town rival that may warrant a higher valuation. It has far less debt, for starters. And it has a stronger position in fast-growing China.

But operationally GM is still lagging: the pre-tax margin on its global autos business was 5.7 percent in the second quarter. After years of losses and in a fairly low-margin industry, that s worth shouting about. But it falls shy of Ford s 7.2 percent margin in the same period. There s an even bigger gap of more than three percentage points between the margins the two manufacturers make in the key North American market.

Being generous to GM, assume the company should trade on the same price-to-earnings multiple as Ford – 6.4 times next year s consensus earnings estimates, according to Reuters. The U.S. Treasury converted $43 billion of emergency loans into a 61 percent equity stake in the revamped GM that emerged from Chapter 11. That means the Motown manufacturer has to be worth about $70 billion for Uncle Sam to break even.

On Ford s PE multiple, GM needs to earn just shy of $11 billion next year to hit the desired target. Extrapolating earnings in the second quarter, GM would make as much as $5 billion this year. But thanks in part to higher commodity prices and other costs expected in the second half of the year, that figure is probably flattering.

If car sales continue to improve GM reckons it can increase production without pushing costs up too much, meaning the bottom line should get a significant boost next year. But it would require a heroic combination of bumper sales and stringent cost control to more than double profit. Until the new GM can prove it s caught – if not overtaken – Ford, it doesn t merit a valuation that will make taxpayers whole.


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