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General Motors Investors: Don't Miss Out On The Warrants

With its current valuation, it's no surprise that value investors are considering investing in General Motors.

GM also has publicly traded warrants that trade with little time premium but nearly four years until expiration.

Bullish GM investors should consider the Class B warrants for their portfolio.

Shares of General Motors (NYSE:GM) have been beaten down over the past few months as concerns over global growth have caused a broad market sell-off. Because of this, GM shares are now looking attractive for opportunistic value investors.

But while I am bullish on the shares, the warrants are a better opportunity for investors expecting significant upside.

Warrant background

Currently GM has three classes of publicly traded warrants, all of which originate from the GM reorganization. The GM Class A Warrants (GM-WSA) and GM Class B Warrants (GM-WSB) were both issued to old GM bondholders while the GM Class C Warrants (GM-WSC) were issued to the VEBA Trust of the UAW.

Since the Class A Warrants expire in July 2016 and the Class C Warrants expire in December 2015, these warrants trade more like options and are more suitable for speculation. Because I look to highlight long-term opportunities I will focus this article on the Class B Warrants which expire July 10, 2019.

Currently, the warrants are deep in-the-money with an exercise price of $18.33. But unlike many of the warrants from major financial institutions, the GM warrants do not have a dividend adjustment feature for ordinary dividends.

At the current trading price of $13.22, the warrants have a time premium of only 5.1% while providing over two times leverage for nearly four years.

Upside

At just over $30 per share, GM trades near the bottom of its 52 week range (excluding the August 24 flash crash). At the same time, the company trades at only 6.6x est. 2015 EPS and 5.8x est. 2016 EPS.

Shares have been beaten down over concerns about global growth, however, EPS estimates have remained strong over the past couple months. In fact, according to data from Yahoo Finance, EPS estimates are marginally higher now than before the market downturn.

The market may also be taking a wait-and-see approach as it waits for GM's higher EPS to actually materialize. Earnings results for 2014 were clouded with one-time recall related costs leading to lower EPS numbers. While future liability expenses cannot be ruled out, putting larger 2015 and 2016 EPS figures in the books could go a long way toward demonstrating GM's earnings power.

Valuing the warrants versus the common stock involves estimating the share price at the July 2019 expiration. While some GM bulls undoubtedly have higher valuation targets, I will use an 8.0x prior year EPS valuation. This represents a wide discount to market averages as well as a slight discount to the current TTM EPS valuation.

Based on NASDAQ data, there is only one 2018 EPS estimate for GM coming in at $7.16 for the year. This estimate is about $1.20 higher than the 2017 est. EPS average. To be conservative, I am discounting the 2018 estimate by 10% to $6.44 which also reflects a modest year-over-year EPS gain compared to the 2017 est. EPS average.

Based on these estimates, GM shares should trade at $51.52 by the expiration of the warrants. Of course this estimate has too many significant figures but it can be used to approximate a general range for the share price if earnings grow as expected.

At the $51.52 share price, the warrants would be worth $33.19 providing a 151% total return based on the current warrant trading price.

During the same time, the common shares would gain 72%. But the common shares will also have access to GM's sizeable dividend. At the current dividend rate, shareholders would also receive $5.40 in dividend bringing the total return to 90%. If GM continues with raising its dividend by $0.06 per share every June as it did in June 2015, shareholders would receive $6.72 in dividends bringing the total return to 94%.

Based on these estimates, the Class B Warrants would widely outperform the common shares with a conservative valuation and an optimistic dividend forecast.

Risks

GM as a whole is highly exposed to economic growth as vehicles sales track closely with consumer demand. Additionally, GM's large China presence provides the growth of an emerging market but also brings the risk of a slowing Chinese economy.

The Class B Warrants would also underperform the shares if the share price were to stagnate as both the time premium and dividends would be lost. This could happen if EPS does not live up to expectations or if the market assigns GM an even lower valuation in 2019.

If GM were to increase its dividend substantially beyond the current rate, the dividend could also help shares perform better in comparison to the warrants. However, a higher dividend could also lead to higher share price allowing for more gains for the warrants.

GM warrant takeaway

With the recent market downturn, shares of GM now trade cheaply and with a significant dividend yield. But for opportunistic value investors seeking to maximize capital appreciation at current market levels, the GM Class B Warrants are definitely worth considering.


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