Pedal to the Metal for GM’s Stock if Margins Kick Into Higher Gear

GM (NYSE:GM) reported solid 2011 Q1 net income a few weeks back. While the company’s revenues increased 15% year-on-year, its adjusted-EBIT ^[1] improved almost 18%. We believe that continued improvement in GM’s operating profits can add significant upside to its stock value. The company competes with other global automakers like Ford (NYSE:F), Daimler AG (NYSE:DAI), Honda (NYSE:HMC), Toyota (NYSE:TM), Hyundai (SEO:005380) and Nissan (PINK:NSANY).

We currently have a Trefis price estimate of $34.95 for General Motors’s stock – about 11% above the current market price.

Cost Containment Adds to Profit Margin Upside

The automotive industry is battling increased pressure from rising commodity prices. Also, the product mix of automotive sales in North America continues to shift towards cars, which are generally less profitable than trucks.

In spite of these challenges, GM expects to make solid improvement in its profit margins for FY 2011 though much work lies ahead. Increased vehicle sales volumes and decreased manufacturing costs in Europe will help profitability, which has been a problem area of late. International earnings overall have also slowed year on year in part due to incentives and promotions tailing off. Finally the company highlighted that it will focus on improving profitability in N. America and expects higher sales prices on new models and lower fixed costs to help. These moves should offset increases in commodity costs and the negatives impacts from a shift in its sales mix.

GM Stock Sensitivity to Margins

Our base case scenario expects GM’s gross margins to improve mildly over our forecast horizon and reach 14.3%.

In the scenario where gross margins outgrow our expectations by 0.2 percentage points every year for all automotive divisions and reaches about 16% by the end of our forecast period, implies GM’s stock price estimate will be over $43 – or more than 25% upside from our current price estimate. The chart above shows the gross margin trend for one of the automotive divisions.

See our complete analysis for General Motors.

1. Earnings before interest and taxes, excluding special items such as one time gains and charges. [↩]