Bullish on GM Stock? Check Out The Bonds

Klotz on Bonds

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<h3>James A. Klotz</h3>

James A. Klotz

Now that General Motors appears to be making strides toward implementing its long-term turnaround strategy, Wall Street is warming to the notion that the beleaguered automaker may yet survive its troubled times.

General Motors’ common stock, 2005’s worst performing component of the Dow Industrial Average, has surged almost 40% this year, and recently a number of major brokerage firms, including Merrill Lynch and Prudential, have upgraded the company.

The reasons cited among analysts for this newfound optimism include the potential cash infusion from the successful sale of a majority stake in GMAC (the company’s financing unit) and the overwhelming response to the GM and Delphi employee buyout offers. GM will eliminate approximately one third of its union workers, while Delphi will pare its union employees by half.

The early retirement packages are expected to save $8 billion a year, $1 billion more than originally anticipated. More important, the buyouts should go a long way toward averting a strike at Delphi, which could be devastating to GM.

Although we fully understand why some analysts are becoming more bullish about General Motors’ prospects, we don’t understand why anyone would buy GM stock because buying its bonds makes much more sense.

Bonds provide impressive yields…

Today, an investor can purchase 9.40% bonds issued by General Motors due in 15 years that yield more than 11.50% and sell for less than 85.00. If investors have a shorter time frame, they can purchase bonds due in October 2008 that yield more than 9.75% to maturity. GM also backs a number of tax-free bonds, which yield approximately 6.50%. For investors in the 28% tax bracket, the tax-equivalent yield is more than 9.00%.

…but aren’t for everyone

It is important to keep in mind that although General Motors’ prospects may be showing signs of improvement, the company is far from out of the woods. GM bonds are rated well below investment grade and are only suitable for speculative investors.

If General Motors is to endure, we expect the bonds to have as much upside as the stock, while providing more than twice the cash flow. If the company should suffer a worse fate, the bonds offer considerably more protection than the common stock in a bankruptcy.

James A. Klotz

President

James A. Klotz is the President of FMSbonds, Inc.
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Jun 29, 2006

Please note that all investing entails risk. Fixed income securities are subject to risks that will affect their value prior to maturity. Some of these risks can be related to changes in market conditions, issuer creditworthiness, and interest rates. This commentary is not a recommendation to buy or sell a specific security. All references to tax-free income refer to U.S. federal income tax. Income earned by certain investors may be subject to the Alternative Minimum Tax (AMT), and or taxation by state and local authorities. Please consult with your tax professional prior to investing. For more information on these topics please click on the “Bond Basics” link below or search by keyword at the top of this page.