Why GM Must Revive Cadillac

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Profitability in the automobiles market has been falling. The reasons for the shrinking bottom lines are manifold, but chief among them are as follows:  Firstly, used car sales in the U.S., the second largest car market in the world, are on the rise. Since, these cars sell for low prices, automakers are being forced to offer discounts and incentives on new cars to remain competitive. A drop in average transaction price per vehicle sold reduces an auto company’s profitability. ((Falling U.S. used-car prices will drive up new-car incentives, Reuters, August 2014))  Secondly, in recent years, most of the gains in the U.S. auto market have come from the luxury car segment. However, the trends within the luxury car segment are such that the total segment has been unable to grow faster than industry wide sales. Consumers, benefiting from generous lease programs and incentives, are preferring to buy smaller luxury cars. [1] Even though luxury car sales only contribute about 10-12% of overall sales, they contribute nearly half the sector’s profits. Thirdly, most of the growth in the global auto market is expected to come from the emerging markets.  Sales growth in these markets is driven by smaller cars. The margins on these cars is usually lower than on sedans and SUVs.

As a result, car companies are being forced to look at other opportunities for improving their margins.  Some companies, like Volkswagen, Toyota, and Ford, have tried to bring all their global production under one platform. The rationale behind this trend is that using standardized production methods not only allows them to lower the marginal cost of production but also allows them to reduce the difficulty of the recall and repair process, should it need to be carried out. Apart from cost cutting, the other path being followed by companies in  search of higher margins is the increasing weight of luxury cars in their sales mix. Consider Volkswagen for example: the German automaker’s luxury brand Audi contributes nearly 40% to its operating profits and has an EBITDA margin of nearly 22%.  The heavy presence of Audi in its sales mix means that the company is able to post EBITDA margins of nearly 12%. (See our full analysis of Volkswagen AG here)

General Motors (NYSE:GM) has been trying to follow a similar strategy since 2012. The U.S. based auto maker has been working hard to revitalize its premium car brand Cadillac.  Reviving sales of Cadillac can help GM reach a pre-tax margin of 10%, nearly 2 percentage points higher than its current pre-tax margin of just under 8%.  For a while, it looked like GM might achieve its targets. However, Cadillac’s sales growth ran out of momentum towards the end of 2013. In the first ten months of 2014, Cadillac sales fell by more than 9.5% in the U.S.  Even though Cadillac has introduced several new models, sales have failed to pick up.

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We have a $40 price estimate for General Motors, which is about 25% higher than the current market price.

See full analysis for General Motors

New Model Launches

In 2012, the Cadillac portfolio was down to just three models — the CTS mid-size car, the SRX crossover, and the Escalade SUV.  Towards the end of the year, the company launched two new models — the XTS full-size sedan, which targeted Cadillac’s pre-existing customer base, and the ATS compact sedan, a car designed to be competitive with the popular German compact luxury cars. The introduction of these two cars worked like a charm for the company, making Cadillac the fastest growing luxury brand in the U.S.  Even though the sales of the CTS, Escalade, and SRX were either falling or stagnant, overall Cadillac sales grew by about 22% in 2013.

Cadillac’s sales momentum began flagging towards the end of fiscal 2013 and deliveries have continued to fall ever since. For the month of July, ATS volumes fell by 11% and XTS volumes fell by 34% compared to the previous year. [2]  On a year-to-date basis, ATS sales are down by nearly 21% and XTS sales are down by 24%.  [3] Both these models performed well in their first year but it appears as though demand for both models peaked last year. The decline in sales can be explained by what the models set out to achieve: the XTS was targeted at Cadillac’s pre-existing customer base and it is clear that that market does not have room for continued growth; the ATS was launched to steal market share from German luxury makers and this is proving difficult for GM. So far this year, BMW has sold over three times the number of cars sold by Cadillac and Mercedes has sold nearly twice that number.

Outlook

Surprisingly, Cadillac’s older models have all posted gains in the number of unit sales in 2014, with the Escalade SUV the biggest gainer at a sales growth rate of 35% on a year-to-date basis [3]. GM launched a re-modeled version of the Escalade late last year. The model refresh has been extremely successful and sales of the model have nearly doubled so far this year. GM now holds 37% market share in the large luxury SUV segment. [3] Another Cadillac model to post a sales increase this year has been the SRX crossover, which is benefiting from the surging popularity of small utility vehicles. However, GM might not be able to cash in on this trend as small utility vehicles will be one of the last segments to be refreshed by the company. Cadillac is expected to offer a redesigned SRX for the 2016 model year. GM also has plans to introduce 2 more Cadillac crossovers around 2017. The luxury crossover market is booming but GM has decided to focus on updating other models before its SUVs and crossovers. Consequently, it is hard to foresee Cadillac posing a credible challenge to the likes of BMW, Mercedes, and Audi.

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Notes:
  1. Luxury Share of U.S. Auto Market Remains in 10-11% Range, Polk, January 2014 []
  2. General Motors U.S. Sales Up 9 Percent To 100,122 Units In July 2014: By The Numbers, GM Authority, August 2014 []
  3. General Motors U.S. Sales Up 9 Percent To 100,122 Units In July 2014: By The Numbers, GM Authority, August 2014 [] [] []