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GM's Dividend Safety Profile Not yet Affected by Union Strike but the Long-Term Stakes Are High

General Motors (GM) remains locked in its longest labor dispute since 1970, costing the company more than $1 billion according to JPMorgan Chase and The Wall Street Journal.

Nearly half of GM's workforce is represented by the United Auto Workers (UAW) union. The automaker's contract with the UAW expired last month, with the UAW's nationwide strike beginning on September 16 as they seek better terms.

GM's stock has slumped 12% since the strike began, and its dividend yield now hovers near 4.5%. Many of GM's factories have idled, the company's finished car inventory is drawing down, and each passing day becomes more costly with lost vehicle production.

Anderson Economic Group, a Michigan consulting firm with expertise in the auto industry, believes GM's daily losses have ramped up from $10 million per day to up to $90 million daily as the strike enters its fourth week. The firm believes GM's cumulative lost profits totaled $660 million through October 6.

Those are scary numbers. However, unless the strike persists for another month or so and a sharper downturn in auto sales occurs, it seems unlikely to threaten GM's dividend.

On August 1, GM reaffirmed its full year outlook calling for automotive free cash flow of $4.5 billion to $6 billion. The company's dividend costs about $2.2 billion annually, leaving more than $2 billion of flexibility based on management's last pre-strike forecast.

GM's balance sheet also remains strong, with liquidity and leverage near the favorable ends of the firm's target ranges (see slide below). The automaker's cash and marketable securities total $17.5 billion, and GM has another $16.5 billion available through its credit facilities.

That cushion is meant to help GM weather a future downturn in the cyclical auto industry. However, the company could use $4 billion of its available liquidity to manage through the strike and still remain within its targeted ranges.
Source: General Motors Earnings Presentation

GM is also working on a "transformational" cost savings plan which realized $1.1 billion in savings through the first half of 2019. As of August, management believed the company was on track to achieve $2 billion to $2.5 billion in savings through 2019, providing further cushion for the dividend.

With that said, GM's contract negotiations with the UAW could play a large role in the company's future competitiveness and financial flexibility. The auto industry appears poised to change in a big way over the next decade.

GM believes all-electric, self-driving vehicles are the future and continues pouring money into its Cruise division ($400 million operating loss in the first half of 2019).

Management wants to evolve GM's business model to become more of a technology company that also makes cars, focusing on opportunities such as ride-hailing services that use self-driving vehicles. If more people opt to buy rides rather than own cars in the future, GM wants to be positioned as a leader.

In 2017, GM's ex-President Dan Ammann, who now leads Cruise, said GM makes about $30,000 for each car it builds, including future maintenance work. However, by selling rides in driverless cars, he optimistically believed GM could make "hundreds of thousands of dollars per car," according to a 2018 CNN article.

The UAW understandably feels threatened by this future. For example, electric vehicles require fewer parts and are easier to assemble, reducing the amount of labor and equipment needed. A future with lower car ownership could also shrink GM's factory footprint.

The UAW's stakes are high for this negotiation to protect the pay and job security of its members. Besides better wages and benefits, rumors are that the union is demanding a stronger guarantee that GM will continue building traditional vehicles.

From GM's perspective, developing safe and effective electric and self-driving cars requires substantial investment. Since 2016 Cruise has increased its staff from 40 to 1,500 and commercial deployment of autonomous vehicles is taking the industry more time and money than previously expected.

GM does not want to be saddled with unreasonably high labor commitments as the industry evolves and its need for reinvestment likely rises. Non-traditional competitors such as Uber, Tesla, and Waymo (Google) don't have similar anchors.

Until a new labor agreement is reached and the long-term financial implications are clearer, it's hard to draw many conclusions at this stage except that GM's dividend will likely remain frozen like it has been since 2016.

The worst-case outcome would be that the dispute drags out several more weeks, costing GM another billion or two in lost profits (reducing its cushion for a cyclical downturn in auto sales), and the UAW walks away with terms that hamper GM's future ability to invest in electric and self-driving vehicles.

If this scenario were to occur, then GM's Dividend Safety Score would likely be downgraded to Borderline Safe. I would also consider exiting our position in the company (we have small positions in our Top 20 Dividend Stocks and Conservative Retirees portfolios) since GM's appeal centers on its ability to deliver safe current income while investors wait for the firm's self-driving car initiatives to pay off.

Since GM's BBB credit rating from Standard & Poor's is only two rungs above junk status, it's also important that a reasonable resolution is reached sooner than later to ensure the company's liquidity and access to affordable financing remain intact.

GM next reports earnings on October 29, providing management with an opportunity to clarify the financial implications of the strike, which will hopefully be over by then. We will continue monitoring the situation for any material developments that could affect GM's dividend safety and long-term outlook.

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