Streetwise for Sunday Nov 23, 2008

Streetwise

Lauren Rudd

Sunday, November 23, 2008

Detroit Redux

Seldom has a column generated the response seen last week, with the vast majority of comments favoring letting General Motors, Ford and Chrysler file for bankruptcy. The Big Three could then operate using “debtor in possession” financing, backed by the federal government. In addition, the government could also guarantee that warranty claims would be honored, thereby eliminating the “no one would buy” argument.

Bankruptcy would enable all three to unshackle themselves from labor contracts and dealership agreements that are a holdover from a bygone era, a time when the domestics operated virtually without competition, dividing up 95 percent of an expanding market.

Today, GM and Chrysler need to merge and drop unprofitable divisions. GM’s hourly wage is $10 to $20 higher than the same position would garner at a foreign owned plant in the U.S. Where I live in Florida, $20 an hour is just a dream for many workers, especially the unemployed.

As of 2007, the average GM worker earned $70 per hour, if you include benefits. In other words, they were paid $140,000 per year to work on an automobile assembly line. Even laid-off workers draw a check.

At their stated $5 billion per month burn rate, if GM were to receive its requested $12 billion in emergency funding, the money would be gone by the end of January. Then what? Assume the government carried GM for a full year. Even if the economy rebounds, there is no planned realignment of GM’s cost structure. And, according to the minutes of the Fed’s Oct. 28-29 meeting, 2009 will be lean...at best.

Those readers who were beset with anger over what I wrote did have employment ties to Detroit. At least three readers forwarded the column to the headquarters of the United Auto Workers with the request that the UAW “take action to set me straight.”

I would be pleased to sit down and interview Mr. Ron Gettelfinger, president of the UAW. I would like to know why the taxpaying public, many of whom do not have health insurance or full pay if laid off, should be subsidizing the auto industry’s 14-carat benefits program, along with the corporate jets and multimillion dollar salaries of top management.

It should be obvious by now that in terms of your portfolio, GM is not a poster child of investment desirability. More to the point, should you be investing in stocks at all given Wall Street’s recent performance? Yes, because a solid, dividend paying company whose shares are under priced is always a bargain in any market.

A good example is Cubic Corporation (CUB). The company engages in the design, development and manufacture of defense electronics and transportation fare collection systems. Both markets are relatively recession proof.

For the third quarter ended June 30, 2008, earnings were $8.5 million or $0.32 per share, as compared to $11.2 million a year ago. Sales for the third quarter were $232.9 million, as compared to $233.7 million in the same quarter last year. However, last year's third quarter sales number included $3.1 million from the sale of a corrugated box business.

Sales were also impacted this year by a transition of work from the engineering development phase, where revenue is recognized on a percentage completion basis, to the production phase, where revenues are not realized until the product is delivered and the sales process is complete.

A discounted earnings model, using a 17 percent earnings growth rate and a 15 percent discount rate, produces an intrinsic value of $49 per share. The more conservative free cash flow to the firm model suggests an intrinsic value of $48 per share. Both results are more than double the recent share price of $20.54.