Now that General Motors appears to be making strides toward implementing its long-term turnaround strategy, Wall Street is warming to the notion that the beleaguered automaker may yet survive its troubled times.
General Motors’ common stock, 2005’s worst performing component of the Dow Industrial Average, has surged almost 40% this year, and recently a number of major brokerage firms, including Merrill Lynch and Prudential, have upgraded the company.
The reasons cited among analysts for this newfound optimism include the potential cash infusion from the successful sale of a majority stake in GMAC (the company’s financing unit) and the overwhelming response to the GM and Delphi employee buyout offers. GM will eliminate approximately one third of its union workers, while Delphi will pare its union employees by half.
The early retirement packages are expected to save $8 billion a year, $1 billion more than originally anticipated. More important, the buyouts should go a long way toward averting a strike at Delphi, which could be devastating to GM.
Although we fully understand why some analysts are becoming more bullish about General Motors’ prospects, we don’t understand why anyone would buy GM stock because buying its bonds makes much more sense.
Bonds provide impressive yields…
Today, an investor can purchase 9.40% bonds issued by General Motors due in 15 years that yield more than 11.50% and sell for less than 85.00. If investors have a shorter time frame, they can purchase bonds due in October 2008 that yield more than 9.75% to maturity. GM also backs a number of tax-free bonds, which yield approximately 6.50%. For investors in the 28% tax bracket, the tax-equivalent yield is more than 9.00%.
…but aren’t for everyone
It is important to keep in mind that although General Motors’ prospects may be showing signs of improvement, the company is far from out of the woods. GM bonds are rated well below investment grade and are only suitable for speculative investors.
If General Motors is to endure, we expect the bonds to have as much upside as the stock, while providing more than twice the cash flow. If the company should suffer a worse fate, the bonds offer considerably more protection than the common stock in a bankruptcy.
