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NEW YORK (CNNMoney.com) -
This year will probably be remembered as the one when the wheels fell off of General Motors Corp.
The world's largest automaker has been battered by all kinds of bad news -- it's lost $3.8 billion through September, its sales and market share are sinking and rating agencies cut its debt to "junk" bond status. This week analysts at credit ratings agency Standard & Poor's said that chances of a bankruptcy at the automaker were "not far fetched."
GM (Research) has had to resort to large incentives to sell its cars, such as offering them to the public at employee-discount levels. Its stock has tumbled more than 40 percent this year, easily the worst performance of any stock in the Dow industrials.
So it would appear to be a curious time to ask whether GM's stock or bonds are a buy. But the prices of both have sunk enough to make the question worth exploring.
The reason GM's securities have tumbled? Investors are factoring in a significant threat of a bankruptcy filing into the value of GM's stock and bonds. But GM has insisted that there will not be a bankruptcy filing and that planned job cuts and plant closings will help stem its losses.
If the company does climb back into the black, there would likely be a nice rebound for GM's stock and bonds. But how likely is a return to profitability in the near future?
The stock has few fans
If you're extremely adventurous, the stock could be worth a look at these levels. In fact, four analysts actually rate GM a "buy." But six analysts rate GM a "hold" and seven have an outright "sell" call on the stock. For many, the bankruptcy risks are just too high.
Banc of America Securities auto analyst Ron Tadross estimates the chance of of GM filing for bankruptcy protection from creditors over the next two years is about 40 percent and that an eventual filing is "inevitable."
Many analysts also question whether GM's cash on hand -- $19.2 billion at the end of the third quarter -- is as strong as it appears at first glance. The Securities and Exchange Commission is looking into GM's accounting practices, including its relationships with suppliers.
The company also faces risks from the bankruptcy of auto parts supplier Delphi, a spin-off of GM that is still GM's largest supplier. Delphi is demanding steep pay cuts from its union members and due to contractual obligations, GM may be forced to help buy out some employees at its former unit. GM has said it could be on the hook for as much as $12 billion due to the problems at Delphi.
A strike at Delphi is possible as well and Robert Hinchliffe, an auto analyst with UBS Securities, estimates that GM would burn through $1 billion to $1.5 billion a week if its own North American operations are shut down by a strike at its key supplier.
Another analyst said that even if GM does avoid bankruptcy, the stock is still only for the most daring of investors.
"I don't buy the bankruptcy talk. I think they have the resources to get through this," said David Healy, analyst with Burnham Securities. "The stock has gotten so banged up, it could be an interesting speculation play. But I'm not going to try it myself."
Is GMAC a good play?
While GM's core automotive operations struggle, GMAC, its finance unit, has been going strong. The unit is on course to deliver record profits in the neighborhood of $3 billion this year thanks to growth beyond auto finance.
GMAC's mortgage business produced more than half of the division's income the first three quarters of the year, and GMAC's insurance business posted gains even after factoring in a hit due to Hurricane Katrina in the third quarter. With that in mind, some say that GMAC bonds may be the only worthwhile investment in GM these days.
Most of GM's debt outside of its GMAC finance unit is longer-term, and it is generally trading at a steep discount – between 65 to 67 cents on the dollar for bonds that mature in 2016, based on prices late this week. But since GMAC is by far the most profitable unit of GM, its bonds are trading at far less of a discount – 90 or 91 cents on the dollar for bonds maturing in 2014.
The main reason GMAC's debt trades at a premium to its parent's bonds is GM has announced plans to sell a majority stake in GMAC so the finance operation can regain an investment grade rating on its debt. Without that improved rating, GMAC's profits could eventually be wiped out by higher borrowing costs.
If and when a sale goes through, GMAC debt will likely be more valuable again. But there's a catch. Traders specializing in distressed company debt are already making this assumption. So getting a strong return from even that play could be tricky, though the bonds could provide a steady return for patient investors.
Healy, who owns some GMAC debt himself, said he bought the bonds several years ago for its income potential.
A three-year GMAC bond is currently paying a 9.25 percent annualized yield. A 10-year Treasury note currently yields about 4.4 percent and GM's stock pays a dividend equal to an 8.9 percent yield. But there are some doubts about how much longer GM can support that dividend. For more, click here.
A risky bet, even at current prices
If GM does avoid bankruptcy, the rewards could be handsome for investors.
Earlier this decade, the company's stock traded between 6 and 10 times earnings. So if GM's profits were to eventually get back to about a $5 a share, which is still less than the company earned during the past three years, that could lift the stock to the $30 to $50 range, a gain of about 35 to 125 percent from current prices.
Still, those are all very big ifs. Even GM's top executives aren't forecasting when the company will return to profitability.
Putting aside all GM's cost concerns, its basic problem is the lack of appeal of its cars and trucks.
The company is counting on newly redesigned large sport/utility vehicles and pickups due out early in 2007 to end that slump. But with many concerned about high gasoline prices, sales numbers show consumers are switching to smaller car-based SUVs, an area where GM has little to offer.
So unless you have an iron-clad stomach, making any investment in GM is probably not a good idea right now.
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For a closer look at the strength of GM's cash reserves, click here
For a look the details of GM's plans to close plants and cut staff, click here.
For a look at the perfect storm of problems hitting GM, click here.
None of the analysts quoted in this story own any GM stock or GM bonds, other than Healy's previously mentioned ownership of GMAC bonds.
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