This Old Economy Company Could Be a Buy
There are always surprises in the stock market. In recent news, we learned a company that seemed destined for the dust heap of history several times is having a good year again and that could make the stock attractive.
The Wall Street Journal recently reported that General Motors Co. (NYSE: GM) said its earnings are picking up speed, with added momentum due to come this year from plant closures and job cuts denounced by President Trump.
Mr. Trump criticized GM Chief Executive Mary Barra in November after she outlined plans to shut several U.S. factories and lay off thousands of workers. Ms. Barra was summoned to Washington, D.C., by lawmakers irate about the potential fallout of GM’s cuts on their communities.
The backlash notwithstanding, GM said Friday that its largest restructuring since its 2009 bankruptcy will have a speedy impact on its bottom line. The cuts to its North American operations should boost operating profit in 2019 by nearly 20%, or by more than $2 billion, with more benefit expected in 2020.
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The Detroit-based auto maker also raised its guidance for last year’s earnings, ahead of reporting its 2018 results on Feb. 6.
GM’s shares rose sharply on the news.
Ms. Barra, now five years into her tenure, has led the largest U.S. auto maker by sales to record profits in part by jettisoning slow-growing or unprofitable business units, including GM’s European division in a 2017 sale.
She is currently focused on cutting costs and improving cash flow to sustain strong results in the event the U.S. auto market cools, while still funneling money toward future bets on electric and self-driving vehicles. GM’s restructuring includes idling five factories in the U.S. and Canada this year, part of a plan that could cut around 14,000 employees en route to slashing $6 billion in annual cash costs by 2020.
“We know time is not our friend,” Ms. Barra told analysts Friday. “These were difficult decisions because they impacted people.”
GM has said most of the 2,800 U.S. hourly factory workers at risk of losing their jobs should be able to catch on at other GM plants if they are willing to commute or relocate.
The company also tried to relieve concerns of a significant decline in the world’s largest car market, China. Slowing growth in China has rattled U.S. companies and the stock market, exacerbated by Apple Inc.’s revenue warning to start the year, which the phone maker blamed largely on a sluggish Chinese demand.
GM said its profit could slip this year in China, where GM’s sales declined 25% in the fourth quarter. But Ms. Barra expects industrywide sales there to hold steady in 2019, and said she is encouraged by recent trade talks between the U.S. and China and Beijing’s signal it could introduce consumer stimulus.
GM said its expects earnings per share this year of $6.50 to $7. The average analyst estimate was below $6. The continued U.S. rollout of new pickup-truck models—the company’s most lucrative products—should boost profit, along with the savings from reductions in its North American workforce.
GM said it would continue spending heavily on autonomous-vehicle development this year, likely matching the roughly $1 billion it was on track to spend in 2018. Executives reiterated plans to begin a commercial robot-taxi service in an undisclosed U.S. city sometime this year.
The auto maker also has said it plans to double spending on electric vehicles in coming years, though it hasn’t quantified the investment. On Friday, GM said its luxury Cadillac brand would serve as its “lead electric-vehicle brand,” without detailing plans for specific models.
GM projected industrywide sales in the U.S. this year will come close to the 17.3 million vehicles sold in 2018, a historically strong number.
RBC Capital analyst Joe Spak said GM’s 2019 profit outlook is stronger than he expected, while noting that the company’s bullish view relies on continued strength in China and the U.S., the world’s two biggest car markets.
“We, and we believe the market, have taken a more conservative approach to thinking about 2019,” Mr. Spak wrote in a research note.
This news could mark a bottom for the stock.
A Trade for Short Term Bulls
As with the ownership of any stock, buying GM could require a significant amount of capital and exposes the investor to standard risks of owning a stock.
To reduce the risks of a trade, an investor could purchase a call option. This allows them to benefit from upside moves in the stock while limiting risk to the amount paid for the options. However, buying a call option can also require a significant amount of capital and includes the risk of a 100% loss.
Whenever an option is bought, the maximum risk is always equal to 100% of the amount of spent to purchase the option. Since options cost significantly less than a stock, the risk in dollar terms will usually be relatively small to own an option.
To further limit the risks of the trade, an investor could use a bull call spread. This strategy consists of buying one call option and selling another at a higher strike price to help pay for the cost of buying the first call. The spread strategy always reduces the risk of an options trade.
This strategy is designed to profit from a gain in the underlying stock’s price but has the benefit of avoiding the large up-front capital outlay and downside risk of outright stock ownership. The potential risks and rewards of this strategy are summarized in the chart below.
Source: The Options Industry Council
Both the potential profit and loss for the bull call spread are limited. The maximum loss is equal to the net premium paid when the trade is opened. The maximum profit is limited to the difference between the strike prices, less the debit paid to put on the position.
This strategy could be especially appealing with high prices stocks where the share price and options premiums are often a significant commitment of capital for smaller investors.
A Specific Trade for GM
For GM, the February 15 options allow a trader to gain exposure to the stock.
A February 15 $39 call option can be bought for about $0.72 and the February 15 $41 call could be sold for about $0.30. This trade would cost $0.42 to open, or $42 since each contract covers 100 shares of stock.
The amount paid to enter the trade is the largest possible loss on the trade. This is generally true whenever a trader is creating a debit to enter an options trade. “Creating a debit” means there is a cost to enter the trade. You could create a debit by simply buying puts or calls to open a directional trade.
In this trade, the maximum loss would be equal to the amount spent to open the trade, or $42.
The maximum gain on the trade is equal to the difference in exercise prices less the amount of the premium paid to open the trade.
For this trade in GM the maximum gain is $1.58 ($41 – $39 = $2.00; $2.00 – $0.42 = $1.58). This represents $158 per contract since each contract covers 100 shares.
Most brokers will require minimum trading capital equal to the risk on the trade, or $42 to open this trade.
That is a potential gain of about 276% based on the amount risked in the trade. The trade could be closed early if the maximum gain is realized before the options expire.
In this trade, options provide income and defined risk. These are the type of strategies that are explained and used in TradingTips.com’s Extreme Profits Calendar service. This service uses seasonals as one indicator in its trade selection process. To learn more about how options can be used to meet your goals, click here for details on Extreme Profits Calendar.