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General Motors: One of Warren Buffett's Dividend Stocks

General Motors (GM) was founded in 1897 in Detroit, Michigan, and is one of the largest carmakers in the world. The company sold 8.4 million vehicles globally in 2018, earning 8.9% global market share and 16.7% share of its core U.S. market. 

General Motors has embarked on a multi-year strategy to redesign and expand its truck and crossover portfolio, which is more profitable and growing faster than passenger cars. On a retail basis, close to 80% of GM's U.S. sales are now pickup trucks and crossovers, and management plans to significantly reduce the number of sedans it sells in the U.S. going forward. 

The company markets its cars and trucks under the following brands:

  • Chevrolet
  • Buick
  • GMC
  • Cadillac
  • Wuling (China)
  • Baojun (China)
  • Jiefang (China)
  • Holden (Australia)
Source: GM
In July 2017, GM closed on the sale of its perennially unprofitable European operations for $2.3 billion. As a result, 78% of GM's 2018 revenue was derived in North America, 13% from international vehicle sales, and 10% from its financing business.

Similarly, North America accounts for nearly all of General Motors' profits:

  • North America: 82% of operating income
  • International: 3%
  • Finance: 15%

Business Analysis
The auto business, in general, is a very harsh one, thanks to high levels of global competition, cyclical sales, and massive capital intensity. Auto manufacturers face a constant need to design, launch, and update their vehicles to remain competitive and maintain market share.

In 2018 alone, for example, GM spent $7.8 billion on R&D (5.3% of revenue) to develop or refresh its model lines. In addition, restructuring charges related to adapting its business model totaled $1.2 billion in the company's North American segment alone (mostly from buying out salaried workers and idling factories producing unprofitable sedans). 

U.S. automakers have had an especially rough go of it in the last few decades due to several unique historical quirks that once had American auto giants such as GM flying high, but later became a massive albatross around their necks.

A major disadvantage is the fact that nearly half of GM's workforce remains unionized, and after World War II the company's dominant position in both the U.S. and global auto markets (GM had about 50% market share at its peak) allowed it to strike favorable deals with unions for healthcare and pension benefits. 

Since it was swimming in cash thanks to pent-up demand for cars following the war, GM was able to have exceptionally good labor relations with its heavily unionized workforce. The company offered them large pensions, free healthcare for life, generous annual raises, and other perks.

However, this unique situation created problems for GM. The company's dominance resulted in GM resting on its laurels in terms of R&D, especially when it came to poor vehicle reliability and low fuel economy. This opened the door for foreign automakers to enter the U.S. market and take share since many of their vehicles offered better reliability and fuel economy, and they weren't saddled with GM's bloated cost structure.

In fact, according to The Center for Automotive Research, by 2008 GM was spending 50% more per hour per worker (adding $1,200 to its cars) relative to its Japanese competitors.

When the financial crisis hit, GM's debt load, plus unfunded liabilities (future pension and healthcare obligations) had ballooned to $104 billion ($17 billion which was due within a year), compared to just $14 billion in non-restricted cash on the balance sheet.

In addition, GM's finance arm (which was later spun off as Ally Financial) had made numerous subprime loans that imploded and resulted in massive losses, including $9.6 billion in the fourth quarter of 2008.

This forced GM to accept a $50 billion bailout from the U.S. government (in the form of a 61% equity stake, plus preferred shares and a loan) as it declared bankruptcy.

In fairness to GM, the company managed to do a solid job of righting the ship, having made numerous painful but necessary changes to become a far better managed, competitive, and profitable company. These actions included:

  • Shut down or sold numerous unprofitable brands, such as Hummer, Pontiac, Saturn, and Saab
  • Closed 2,300 dealerships
  • Closed about a third of its factories
  • Laid off over 30,000 workers (unionized employees down from 67% of GM's total workforce in 2009 to 49% in 2018)
  • Eliminated nearly $80 billion of debt
  • Worked with Ford and Chrysler to create the Voluntary Beneficiaries Association, which pushed future healthcare trust funding onto the United Automobile Workers union, thus saving GM $3 billion per year

GM has also become much more disciplined with its business, reducing the number of cars it sells to rental fleets. These tend to be low-margin vehicles that did little more than fill capacity at the company's factories.

Ford and Chrysler have taken similar restructuring actions, even showing a willingness to give up some market share to maintain their focus on profits. That's a big change from the past. 

For example, in 2007 when the Big Three (GM, Ford, and Chrysler) built more than half of all vehicles sold in the U.S. car market, they were losing more than $300 per car produced, according to The Wall Street Journal. 

Just one decade later, and despite lower market share, the Big Three profited more than $2,500 for every car made in North America. GM alone made $8.1 billion in 2018 profits, thanks to a focus on fewer production platforms as well as the popularity of higher-margin SUVs and crossovers. 

The company has also closed the quality gap with industry leaders like Toyota (who also makes Lexus), especially for some of its top brands like Chevy and Buick. For example, Chevy has been the best selling truck brand in the U.S. for five years in a row. GM has touted these improvements in its commercials for several years and is likely an important reason its U.S. market share has stabilized in recent years.
Source: J.D. Power
Another structural change supporting GM's improved profitability and vehicle reliability is management's focus on streamlining its production capacity over time. Management expects 75% of the company's global sales volume will come from just five vehicle architectures by early next decade, according to GM's 2018 annual report. For context, the automaker had 24 vehicle platforms in 2014.  

In November 2018 GM also announced a major restructuring plan that is designed to preemptively prepare the company not only for the next recession but also to help it compete more effectively in the future. That plan includes:

  • Reducing its workforce by 8,100, or 15%
  • Eliminating six sedan models that aren't profitable (and closing or repurposing the five factories that make them)
  • Cutting annual capex by $1.5 billion (a nearly 20% reduction)
  • Redirecting savings to R&D activities for electric and autonomous vehicles (GM's Cruise driverless car business was valued at $14.6 billion based on its last round of funding in 2018) 

Basically, GM wants to think ahead for the future while also not being caught flatfooted when the next industry downturn strikes.

GM says that its restructuring plan, once completed, will save it $4.5 billion per year by the end of 2020. When combined with reduced capex, this could provide a $6 billion boost to annual cash flow. During the restructuring, the company expects to have to spend $3.8 billion ($2 billion in cash) to cover expenses associated with reducing its workforce and closing factories.

If successful, the substantial cost savings from a leaner and better adapted GM should help make the company's dividend safer as well. GM's adjusted automotive free cash flow of $4.4 billion in 2018 has potential to rise by several billion dollars over the next few years thanks to the company's restructuring plans (assuming no recession and U.S. auto sales remain stable). 

That's compared to an annual dividend cost of just $2.2 billion per year. When the total restructuring is complete, GM's dividend seems likely to remain safe even during a recession, bolstered by the firm's large cash position (nearly $20 billion at the end of 2018) and borrowing power.

According to comments made by GM's former CFO Chuck Stevens in 2017, GM's breakeven point is 10 million to 11 million annual US auto sales. For context, at the height of the Great Recession, U.S. auto sales bottomed at about 9 million, and that was likely made worse by credit markets freezing up. The company's current CFO expects GM's latest restructuring actions to lower the company's breakeven point even more.

GM is confident that its current dividend can be safely maintained over a full business cycle, including during a normal recession. At least that's according to GM's former chief financial officer, Chuck Stevens, who told investors in 2017 the company planned to pay the dividend out of cash reserves until those were exhausted:

“So net-net, in the first year of the downturn, we'd expect to burn about $5 billion, roughly, of free cash flow. Obviously, that risk is factored into our $18 billion target cash reserve to ensure that we can continue to invest through the downturn and maintain our current dividend."

However, GM isn't just betting on the U.S. to sustain its dividend and drive future growth. China, the world's largest auto market, is a key focus for the company. GM's joint ventures in this region include five brands that collectively command about 14% market share, which is among the highest in the Chinese auto industry.

By 2023 GM plans to double the number of electric models on sale in China while also ramping up its investments into U.S. electric vehicles (EVs). Like with its gas-powered models, GM's EV focus will be mostly on SUVs and crossovers, which have become the favored vehicle type around the world. 

The final important piecwe of the business, GM Financial, has also come a long way from the dangerous sub-prime and hyper-leveraged days before the Financial Crisis. Today the financial segment's leverage is just 9.0, and the company plans to maintain leverage at 10.0 or less to ensure a future recession doesn't blow up its balance sheet. 

GM is also making loans to much safer customers (stronger FICO scores) and expects to generate long-term pre-tax profits (paid as a dividend to GM) of about $2 billion while generating healthy returns on equity in the mid-teens.

In 2017 33% of GM Financial's loans were to sub-prime customers, but that figure fell to 25% in 2018. In 2018 the overall delinquency rate on auto loans (over 30 days past due) fell to 4.8% from 5.8% in 2017, which is impressive given that auto delinquency rates were rising nationwide. This shows that GM Finance likely now represents a safer asset, rather than a dangerous liability for the company. 

Overall, GM is making all the right strategic moves to ensure its survival during a future recession, invest for the future (autonomous vehicles, EVs), and stay in strong enough health to maintain its current dividend regardless of the economic environment. 

However, there are several reasons why GM is possibly unsuitable for some dividend growth investors. 

Key Risks
As impressive as GM's turnaround has been, there are a few major issues facing the company when it comes to being able to maintain or grow its dividend.

First, the auto market is very unforgiving, requiring high levels of capital investment, consistent technological innovation, robust supply chains, efficient manufacturing facilities, big marketing budgets, and a strict adherence to safety and environmental regulations. 

Auto companies constantly have to redesign and retool their plants, resulting in massive capital expenditures and R&D spending. For example, GM routinely spends more than $12 billion on capital expenditures and R&D each year.

GM's pension obligations, while drastically lower than pre-bankruptcy, are costly as well. Between 2016 and 2018 GM spent $6 billion on its pension funds, which represents a cost that many of its foreign rivals (like Toyota and Honda) don't have to deal with.

And because auto sales are cyclical but production plants have high fixed costs, GM's profits can drop in a hurry when sales volumes plummet. Automakers also have a history of being undisciplined on pricing when conditions get tough, which further strains profitability during down cycles. 

But the highly capital intensive nature of this industry (where companies must spend billions just to maintain constant sales) is just one of the headwinds the company faces.

Another big risk factor today is tariffs, which management expects to increase GM's expenses by $1 billion in 2019. While the U.S. and China are negotiating an end to their trade war, there is no word from the Trump administration on when or if U.S. steel tariffs will ever be eliminated, potentially making this a longer-term issue for GM.

Fortunately, GM still expects cost-cutting activities to help drive earnings and cash flow higher, but the company's short-term results could also be upended by weakness in China. 

Partially due to the trade war, Chinese auto sales in 2018 declined for the first time in nearly 30 years. The highly competitive nature of that market (hundreds of companies) has also resulted in mid-single-digit pricing pressure each year since at least 2012. If China's economy continues slowing down, its auto market could prove to be less of a growth catalyst for GM than investors hope. 

Meanwhile, GM's autonomous vehicle division Cruise, while a promising and rapidly growing company, is still generating losses for GM (-$728 million in 2018). The company invested $700 million into Cruise in 2018 and plans to spend about $1 billion in 2019. 

While Cruise might be a good strategic investment since driverless cars and ridesharing are expected to grow rapidly in the future, there is a lot of uncertainty about when GM's multi-billion dollar investments will start to pay off (and what long-term margins it can achieve). The same is true for the firm's big push into electric vehicles, which CEO Mary Barra said aren't expected to turn a profit "early next decade."

What is more certain is that in an autonomous car future, individual car ownership is likely to fall, potentially representing a secular growth headwind that all automakers face.

It's important to note that GM is an industry leader in driverless cars and ridesharing, which is why Cruise was last valued at nearly $15 billion, and RBC Capital estimates that it might hit $43 billion in a few years. But those high Silicon Valley valuations don't help GM's income-focused investors, who have faced a frozen dividend since 2016.

GM's capital allocation track record since emerging from bankruptcy favors buybacks over dividend increases, which is likely to continue in the future, even if the restructuring delivers on all its promised cost savings and increased cash flow. That's because buybacks are more suited to a highly cyclical and capital intensive industry, compared to dividends which investors generally expect to be maintained in perpetuity. 

Basically, GM's business model is less conducive to generating consistent income growth each year, especially as the auto industry requires so much investment to evolve for the future of driving. Investors considering the company need to instead value the firm's well-run auto operations, generous yield, and unique self-driving vehicle technologies. 

Closing Thoughts on General Motors
GM has risen like a phoenix from the ashes of bankruptcy and made a remarkable turnaround, including a number of structural fixes to its workforce, manufacturing footprint, production mix, and balance sheet. Today's GM appears to be a much more reliable source of income, albeit one with little to offer in the way of dividend growth.

That being said, the auto industry has plenty of imperfections, including stiff competition, cyclical demand trends, high capital intensity, and potential disruption with the potentially inevitable migration to both electric cars and autonomous vehicles in the decades ahead. 

While GM's current dividend seems likely to remain safe even during a recession (barring an extremely severe shock), there is little prospect for long-term income growth as management invests heavily into future technologies that will likely take many years to start generating profits. 

Overall, the cyclical auto industry is not a great place for risk averse income investors to allocate much, if any, of their portfolio. However, for value-focused dividend investors who are less concerned with consistent growth and willing to tolerate some potential volatility and uncertainty in their well-diversified portfolios, GM stands out from the pack. 

The company's reshaped operations and strategic bets on future technology could ultimately lead to much higher margins and more stable profits over the very long term, but a good deal of patience will likely be required.

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