As business stories go, few rival the compelling saga of General Motors in 2006. After a dismal 2005, the company started the year in the doldrums, bleeding financially and losing market share to Japanese and other Asian brands.
Though many investors couldn’t see past the stream of negative headlines, others took a longer view. They saw a unique market opportunity: General Motors bonds could be purchased to yield 12.00% and GMAC bonds were yielding about 8.50%.
During 2006, GM’s turnaround efforts were evident as it rolled out new trucks and cars, strengthened liquidity, reduced losses and sold a controlling interest in GMAC while retaining access to the financing giant for auto financing.
While GM’s efforts to improve were impressive, much work remains to be done. America’s largest automaker still needs to return to profitability, attract customers and keep costs in line to compete effectively in a global economy. Yet the steps taken in 2006 toward those ends have helped stabilize the company and start it down the right track.
Investors who held on for the ride in 2006 were well rewarded, and 2007 looks to build on that foundation.
GMAC
Today, GMAC bonds can still be purchased to yield 7.00%, which is comparable to more than 5.00% for an investor in the 28% tax bracket and more than 4.55% for investors in the 35% tax bracket.
GMAC LLC’s recent sale of $1 billion of five-year bonds marked the first sale of unsecured senior debt by the finance company in two years. GMAC has seen its fortunes improve with the sale of a 51% ownership stake to Cerberus Capital. That sale provides a strengthened capital base for GMAC while improving the outlook for its credit rating.
Although historically profitable, GMAC had found it difficult to enter the unsecured debt markets because of its ownership and control by GM. With the ownership sale, GMAC will now benefit from the separation of its bond rating from those of its former parent, GM. The sale itself has raised GMAC’s rating to the threshold of investment grade, a step it hopes will occur in the near future.
GMAC has also diversified over time into commercial and residential mortgage lending. With its recent majority stake sale, GMAC has indicated it will now seek to provide auto financing to dealers of other makes of cars. By lessening dependence on GM products, GMAC will become a more diversified auto lender, a step the bond rating agencies see as a precursor to higher ratings.
Many current GM dealers also operate dealerships for foreign makes, and GMAC believes these dealers will find GMAC financing attractive for all of their vehicles. GMAC also sees financing opportunities in the used car and sub-prime mortgage markets, business segments it had not entered previously.
General Motors
General Motors bonds can be purchased today to yield 9.60%, comparable to 6.91% for investors in the 28% tax bracket, and about 6.25% for investors in the 35% tax bracket.
General Motors has also made strides toward stabilizing its financial position. The sale of a majority stake in GMAC contributed to an expected year-end 2006 cash balance of $20.4 billion.
GM’s recently completed third-quarter earning results were vastly improved over the same quarter in 2005. Automotive operations improved by $1.5 billion, a result of major cost savings over the year. Year to date, GM North America sharply reduced its loss to $914 million, substantially better than last year’s $4.3 billion.
Although GM’s challenges remain, the tide seems to be turning. A number of successful vehicle introductions and a new emphasis on profit per vehicle have replaced GM’s prior focus on maintaining market share. GM hopes that its recent awards for quality by J.D. Power and others, combined with improving resale values of its vehicles, will win the attention of car and truck buyers who have increasingly turned to foreign car makers in recent years.
We feel that with strong cash balances, GM is in a position to continue new product introductions while focusing on bottom-line improvement, and that GM and GMAC continue to provide exceptional value.
