General Motors: A High-Yield Stock Investing in the Future of Auto

General Motors (GM) was founded in 1897 in Detroit, Michigan, and is one of the largest carmakers in the world. Most of the company's sales are pickup trucks and crossovers, which carry higher margins than passenger cars. 

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 2017, GM sold its perennially unprofitable European operations to focus on market's with higher returns. About 77% of GM's revenue is derived in North America, 13% from international markets, and 10% from its financing division.

North America also accounts for the majority of General Motors' profits. China is another important region, accounting for about 15% of GM's income, but this division's importance is masked in the firm's International segment, which includes several unprofitable operations in other countries:

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

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

For example, GM routinely invests over $7 billion annually in research and development to develop or refresh its model lines. Capital expenditures tack on another $7 billion to $9 billion per year to keep GM's factories humming.

As if these costs, which combine to account for about 10% of GM's total revenue, weren't enough, about half of General Motors' workforce is represented by unions which historically demanded large pensions, free healthcare for life, generous annual raises, and other perks.

The company complied with these demands decades ago when it owned about half of the U.S. market in the 1950s. However, GM eventually rested on its laurels in terms of R&D, allowing foreign automakers to enter the American economy 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 relative to its Japanese competitors.

These issues came to a head during the financial crisis when global auto sales plummeted. GM's debt load, plus unfunded liabilities (future pension and healthcare obligations) ballooned to unsustainable levels, and its finance arm had made numerous subprime loans that resulted in substantial losses. 

This forced GM to accept a $50 billion bailout from the U.S. government as it declared bankruptcy. Management has since overhauled the business, including closing over a third of its factories, exiting Europe, divesting unprofitable brands, reducing its union workforce, and eliminating tens of billions of debt.

Simply put, the industry has become leaner and more rational. 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.

General Motors' core auto business will remain cyclical, but it is on much stronger ground today thanks to management's extensive restructuring efforts. In fact, during the next industry downturn GM expects to break even from a free cash flow perspective.

In addition to its BBB investment-grade credit rating from Standard & Poor's, the company holds $18 billion in cash to help it weather the next cycle. CFO Dhivya Suryadevara says this includes 2 years' worth of dividends that will allow GM to maintain its dividend (about $2.3 billion annually) through the downturn.

However, GM realizes that the greatest threat facing the company isn't an auto downturn, but rather a transportation revolution that leads to a safer world with lower emissions. Specifically, the rise of electric and autonomous vehicles.

GM believes all-electric, self-driving vehicles are the future and continues pouring money into its Cruise division, which in 2019 was valued at $19 billion (over 30% of GM's market cap) after raising funds from SoftBank, Honda, and T. Rowe Price.

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.

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. In 2019 alone GM expects to spend about $1 billion on Cruise.

GM appears to be a leader in this emerging category and hopes to launch its first driverless taxi service in 2020. It's far too soon to say how this market will play out, especially with giants such as Google, Tesla, and other global auto giants all vying for a piece of the pie. However, GM appears to have compelling software and hardware technology all under one roof, making it a competitive player.

Finally, it's worth noting that China, the world's largest auto market, is a key focus for the company. GM's joint ventures in this region collectively command about 14% market share, which is among the highest in the Chinese auto industry.

GM expects demand to rise over time as auto penetration increases. In America there are 800 vehicles per 1,000 people. There are only 140 cars per 1,000 in China, according to management. GM is focused on expanding the number of electric models it sells in China as it believes 1 in 5 of all vehicle sales will be electric vehicles by 2025.

Overall, GM appears to be making the right strategic moves to ensure its survival during a future recession, invest for the future (autonomous and electric vehicles), 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. Developing electric and self-driving vehicles is extremely costly as well and often requires different production capabilities.

As a result, investors are skeptical that GM's ongoing cost savings plans will actually improve the firm's cash flow rather than be redirected towards investments that burn through cash and have uncertain long-term payoffs.  

While Cruise might be a good strategic investment since driverless cars and ridesharing are expected to blossom 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 until sometime in the early 2020s.

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.

Meanwhile, in the short term, GM must contend with trade war headwinds in the form of steel tariffs and weak demand in China. Profits can also be zapped by a downturn in U.S. auto sales given the company's high fixed costs. However, these issues seem unlikely to affect GM's long-term earning power. 

Due to the industry's cyclicality, capital intensity, and need to invest in the future of driving, GM has kept its dividend frozen since 2016, a trend that seems likely to continue. 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 made a remarkable turnaround since its bankruptcy. However, the auto industry still has plenty of imperfections, including stiff competition, cyclical demand trends, high capital intensity, and potential disruption with the expected migration to 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 income growth as management invests heavily into future technologies that will likely take years to start generating profits.

Overall, the cyclical auto industry is not a great place for risk averse investors. 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 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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