Thesis 07/09/12
Although the "Government Motors" stigma is likely to hang over General Motors Company for several years, we think GM's car models are of the best quality and design in decades. The company is already a leader in truck models, so a fully competitive lineup combined with a much smaller cost base leads us to think that GM will be printing money as vehicle demand recovers.
We think GM's earnings potential is excellent because it finally has a healthy North American unit and can focus its U.S. marketing efforts on just four brands instead of eight. The most critical cost-saving measure was setting up a voluntary employees' beneficiary association (VEBA) for the retiree health-care costs of the United Auto Workers. This move saves GM about $3 billion a year; other benefit concessions and plant closings have drastically lowered GM North America's break-even point to U.S. industry sales of about 10.5 million vehicles, assuming 18%-19% share. The actual point varies based on mix and incentive levels. We think the normative demand for U.S. light vehicles is about 16.1 million-17.3 million units, so we expect GM to report excellent earnings growth as vehicle demand comes back during the next few years.
Dramatically better pricing has helped GM to be profitable at volume levels that would have meant billions in losses a few years ago. The Buick LaCrosse, for example, was recently selling for about $7,800 more per unit than in 2009. Simply put, GM makes products for which consumers are willing to pay more than in the past. GM no longer has to overproduce in an attempt to cover high labor costs and then dump cars into rental fleets (which hurts residual values). It now operates in a demand-pull model where it can produce only to meet demand and is structured to break even at the bottom of an economic cycle.
We think the largest threat to profitability is Europe, which has been losing money for a long time. Previous restructuring moves, such as closing the Antwerp plant and buyouts, have not been enough, so GM announced an alliance with struggling French automaker Peugeot in March (GM now owns 7% of Peugeot). The two firms created a purchasing venture with $125 billion in annual buying power. Although the alliance will bring GM more scale in Europe via purchasing and shared vehicle parts and platforms, management acknowledges that additional European restructuring is needed. Capacity must be better utilized or reduced, but union issues make plant closures nearly impossible. We expect GM Europe to remain unprofitable for at least a few more years.
GM stockholders have to consider politics as long as the U.S. Treasury, Canadian and Ontario governments, and the VEBA own about 51% of the actual shares outstanding. We think this ownership will be an overhang on the stock for some time, since the market is afraid that the U.S. Treasury will quickly dump more than 500 million shares on the market. We also expect the VEBA to reduce its stake over time since it needs to monetize its holdings to pay retiree health-care claims. Although these concerns are valid, we see them as short-term issues that will be resolved. We think a patient GM shareholder eventually will be rewarded, as the company is about to see the upside to having a high degree of operating leverage.
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