General Motors Is Starting to Hum

05/11/2011 3:33 pm EST

Focus: STOCKS

George Putnam

Editor, The Turnaround Letter

While the stock idles a bit below its IPO price, its cash flow is dirt cheap and the business is in its best shape in decades, writes George Putnam III in The Turnaround Letter .

We looked at General Motors (GM) stock when it first began trading after the post-bankruptcy initial public offering late last year. Our recommendation then was to wait on GM and consider some of the automotive-parts suppliers instead.

That turned out to be pretty good advice. Since the end of November, GM stock is down about 6%, while the nine suppliers that we highlighted are up an average of about 28%. (The S&P 500 gained 15.5% over the same period.)

Now, however, we are ready to recommend GM.

We have always been impressed by how dramatically the company was reshaped during its brief bankruptcy, but we wanted to get a better sense of several thing—including how management would perform, how the stock would trade, and where the global car market was headed. Most of our concerns have now been alleviated.

GM’s new management team has brought a level of discipline to the company that it hasn’t had in decades. Operations are now leaner, and finances are better managed than they have been in at least a couple of generations.

The company’s product line appears to be experiencing good success both domestically and abroad. Its new models in the US have been well received, and it has others in the pipeline. GM’s joint venture in China is the leader in that burgeoning market.

Worldwide auto sales are expected to continue growing nicely over the next several years, and GM is well positioned to participate in that growth. Even if auto sales stagnate, the new, leaner GM should perform decently.

Valuing GM is still a little tricky, given its recent history, but the stock appears to be trading at around three times EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization, a widely used measure of cash flow). We think it will eventually trade at five times EBITDA or higher.

Of course, not everything is going to be rosy for GM. Rising gas prices and rising raw-material costs could be a stumbling block.

Also, the government still owns about 27% of GM’s stock. How well the government manages the disposition of those shares could have a significant effect on the stock price.

All that said, we like what we see at GM now. We recommend buying General Motors stock up to $40. [Shares traded just above $31 Wednesday—Editor.]

Investors looking for more price leverage—and willing to take on additional volatility—should also look at the GM warrants. The $10 strike price warrant (GM-WTA) expiring July 10, 2016 and the $18.33 strike warrant (GM-WTB) expiring July 10, 2019 are currently “in the money,” but they still have more upside leverage than the stock.

Of course, warrants can be quite volatile. And like an option, a warrant will be worthless if the stock price is below the exercise price when the warrant expires. But unlike options, these warrants have multiple-year lives.

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