By Michael Medvedev
NYSE – GM
Price: $35.53 (Date of price: 1/9/2019)
Price Target: $45.00
P/E Ratio: 58.25
EPS: 0.61
52-week Range: $30.56 – $45.52
Market Capitalization: $49.653 billion
Shares Outstanding: 1.411 billion
Overall Markets and Auto Industry
Since 2017 there has been a dramatic transition in market conditions from long-running market stability to a drastic increase in volatility and price fluctuations as a result of trade wars, rising interest rates, and concerns around slowing economic growth. In a market with greater and more frequent losses––caused by the increase in volatility––it might be an intelligent decision to add a low beta or stable dividend stock in order to lower volatility and stabilize one’s portfolio. Since vehicle sales peaked in 2016 (Figure below), the auto industry has been a market to avoid for several reasons: investment banks downgraded the sector ratings; industry dynamics changed due to the rise of car-sharing services (Uber and Lyft); millenials are buying cars at a slower rate than previous generations. However, GM’s recent activity shows otherwise and indicates its futuristic outlook as a company prepared to thrive and spearhead the future of vehicles (namely, with electric vehicles).
Company Overview
General Motors Company, or General Motors (GM), is an American multinational corporation which designs, manufactures, markets, and distributes vehicles (6 brands) and vehicle parts. It is the largest automobile manufacturer in the United States and one of the largests car manufacturers in the world. GM manufactures vehicles in 37 countries and has investments in multiple foreign brands.
History of General Motors
Along with most companies, the 2008 recession left GM with $31 billion in the red, making them unable to pay their suppliers and meet loan obligations or cover health care costs of its workers. However, with the Obama administration’s assistance, GM successfully survived failure by spinning out assets (creating more cash flow) and being granted billions in taxpayer funds. Soon after, they announced a government-backed Chapter-11 bankruptcy, restructured their leadership, killed off unprofitable brands, and focused more on producing fuel-efficient vehicles. With over $50 billion in government assistance – and all but around $10 billion repaid – it is safe to say that the government had a major impact on the turnaround of the auto industry. Following the recession, a successful IPO, and a steady increase in vehicle sales and net revenue fueled the company and got it back up and running… on all four wheels.
Recent Developments:
As of November 26, 2018, GM announced their plans for restructuring their business, outlining their vision for the future. Their plan includes eliminating up to 14,700 jobs (8.2% of all GM’s employees) and idling production in 5 plants. 57% of those job eliminated are in the US. In addition GM plans to cut salaried staff by 15%, 8,100 employees and end production of several passenger cars including the Chevrolet Cruze, Volt, and Impala, the Buick LaCrosse, and the Cadillac CT6.
Why? / Catalysts
1. Preempting a possible Recession
Auto sales depend on consumer confidence, which in turn is correlated to economic cycles and markets. In a good year, light vehicle (Cars, SUVs, and Pickups) sales are expected to reach 17 million vehicles, while during a recession, sales drop to 12 million. The cycle exists because after a certain number of years, individuals need to buy a new car. An individuals income induces one to hold on to their car a little longer as opposed to re-entering the automobile market. Therefore, if income declines in all income categories, less individuals will enter the market leading to less sales. These drops in sales have a big impact on GM’s profit margins due to high fixed costs – labor contracts, factories, and imports of material. With the planned restructuring, GM benefits by lowering its break-even point (amount of units sold to break even) which would keep it profitable during a possible recession. With a prolonged expansion period and a nearing inverted yield curve, a predictable and inevitable recession seems likely in the imminent future.
2. Leader of Future Technologies
Since its birth in 1908, GM has been a top leader in its industry, producing larger variety and more efficient vehicles than its competitors. GM’s recent restructuring plan comes at time of changing consumer interests and the rise of other technologically advanced auto manufacturers (i.e. Tesla). With an increasing demand for electric vehicles (EVs) and the availability of the sustainable technology to produce such vehicles, GM is left with no choice but to adapt to these changing times in order to stay ahead of its competitors and be positioned to be a leader in future technologies. Staying profitable during a future recession will enable GM to continue research and development of the future technologies, specifically electric and self-driving vehicles. GM announced that it plans on releasing 20 new all-electric vehicles by 2023 and at least 10 in China by 2020. Also, staying profitable allows GM to continue investing in R&D for their already expensive subsidiary GM Cruise, a self-driving unit acquired in 2016. Plans of Dan Ammann, current GM president, leaving his current position and becoming CEO of GM Cruise and $5 billion in investments from SoftBank and Honda conveys how serious GM is about developing self-driving technology and what a lucrative future business it is. GM Cruise plans on launching self-driving taxis in San Francisco by the end of next year, staying ahead of Alphabet Inc’s Waymo, Uber, and Lyft and with a current evaluation of $14.6 billion, many analysts believe its long term value can triple.
Similarly, GM wants to expand future production not only in all battery powered vehicles but also Hydrogen fuel cell vehicles. The difference? While battery powered EVs take time to charge, and fuel cells EVs can be charged in minutes, last longer and are more powerful. Fuel cells make sense in certain applications where battery packs would be too big and heavy, or when recharging times are critical. Perfect customers include SUVs and long distance trucks, first responders that can not afford out of service vehicles for hours to recharge (ex. ambulances), and the US Army that have their own fuel stations and ability for manufacturing renewable hydrogen fuel. Along with its broader electric fleet of vehicles, GM has created a joint venture with Honda to mass produce fuel cells by 2020 and has made it clear that hydrogen will play a big role in its future as well, adding to GM’s commitment for the future in technology. GM’s plans are in line with the direction of the industry. GM is pioneering these radical changes and the competition is or will follow. Volkswagen AG aims to have EVs represent a quarter of its sales by 2025, Nissan and Renault will launch 12 new EVs by 2022, and BMW will launch 12 new fully electric models with mass production beginning in 2020. A reorganized GM will gain a competitive edge in the future, while also prompt its competitors, like Ford Motor Company and others, to make similar internal changes and follow in GM’s footsteps.
3. Factories were unprofitable
The likely reason that GM closed down 5 of its manufacturing plants is because they were unprofitable, or soon to be. With sedans sales falling, these plants – which specialize in producing finished sedans or transmissions – have had their production and labor hours cut. One of the factories located in Ohio builds compact Chevrolet cruze sedans, while cruze sales over the last year have fallen by more than half, it leaves GM little reason to keep the plant running while it approaches its break-even point and eventually begins to lose money when their marginal costs exceed their marginal revenue. While GM is scaling back on cars, it is not scaling back on all passenger vehicles. In fact, SUVs and trucks continue to dominate the market, accounting for two-thirds of vehicle sales in 2017. Low gas prices explain why American car buyers see little reason to not purchase a more flexible and larger vehicle. Ford similarly announced it would stop building cars in North America and would invest more capital in pickups and SUVs, while Fiat Chrysler began to phase out sedans in 2016. With sales also down in China (the world’s largest car market) for the past 5 months and on track for their first annual drop in 20 years, GM is unable to rely on China’s steady growing demand for vehicles and further explains GMs restructuring plan and closing of plants in North America, and possibly in China. The closing of the 5 plants as well comes as a benefit and obvious goal: to boost free cash flow. GM forecasts that the halt of its 5 plants will boost their adjusted free cash flow from roughly $4 billion in 2018, to $10 billion by 2021, enabling GM to focus on investing more in its future vehicles and endeavors.
4. High Costs and Trump
Since the decisions of GM, President Trump has been distressed and fueled with anger to what he believes to be betrayal. Remembering how the government saved GM from collapsing, Trump looks down upon GM’s decision to close factories and lose thousands of American jobs which counters his promises during his political campaign. In hindsight, Trump can partially be the one to blame for GMs actions due to his role in trade wars with China and urge to pass import tariffs. These high tariffs, specifically on steel and aluminum, total over $1 billion in costs for GM in 2018 and are likely to increase in the upcoming years with unclear trade war outcomes, which puts more pressure on the company to cut workers and likely pushed GM to their decision of restructuring. Similarly, Trump’s threats to strip GM of any US government subsidies may sound menacing but in reality will most likely make things worse. Cutting GM subsidies will likely make future vehicles more expensive, hurting auto manufacturing in the US. As well, higher auto import tariffs are likely to fail because they historically result in a net loss of US jobs, lower car production, offshoring of car manufacturing, and a significant hit to the US economy. Lastly, even though thousands of jobs are lost, many are offered opportunities for work in other high demand manufacturing plants.
Conclusion
We believe with GMs wise decisions of switching from an old gas powered vehicle manufacture to a new modern and future oriented company will show great success for the company and stock price in the next decade. The idea that the future of cars is coming seems as certain as ever. GM will no longer sell unprofitable vehicles just to hold market share but plans on becoming a long term leader in both EVs and autonomous vehicles. Through the next recession, GM wants to ensure it can continue to fund future advanced technology product programs, and while its business hits speed bumps as markets slow, GM has proven its well prepared to stay ahead of its competitors in the future which emphasizes its great potential within the next decade.