Three Ways In Which GM’s Stock Can Become More Attractive In 2015

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General Motors (NYSE:GM) is a controversial company. The U.S. auto maker is viewed with suspicion by some because a number of people feel that it should not have been bailed out by the U.S. Government in 2009, and its handling of problems related to ignition switches that led to 27 million car recalls in the U.S. alone in 2014. Nevertheless, the company has improved itself as a business considerably over the last few years and reinvigorated its public image to a large extent. Before the recession, the Detroit based auto maker was known for making gas-guzzling SUVs and pick-up trucks. These vehicles were sold for higher than industry average prices. When gas prices started to increase, customers ditched large SUVs for more fuel-efficient passenger cars and as a result GM’s sales suffered, forcing the company into bankruptcy once the economy turned sour. These days, GM is still heavily reliant on sales of SUVs and pick-up trucks, but it is also a contender in the passenger car segment, a segment that has historically been dominated by Toyota, with Camry and Corolla, and Honda, with Accord and Civic.

GM is rapidly enhancing its reputation as a manufacturer of passenger cars. For example, GM’s Chevrolet Impala was rated as one of the top 10 picks of 2015 by Consumer Reports and garnered a score of 91 out of 100. That score was one of the only three above 90 scores in the list, and the two others cars that got a similar score, Tesla’s Model S and Audi’s A6, both carry a much higher sticker price. Additionally, GM’s Buick brand became the first American car brand to crack the top 10 car brands in Consumer Reports’ Brand Report Card. Considering this, we take a look at three other critical areas which can determine the company’s success going forward.

We have a $40 price estimate for General Motors, which is about 5% more than the current market price.

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China Success

GM sells the second most number of cars in China. Given that China is the world’s largest auto market and still one of the fastest growing, it can be the source of an increasing amount of profit for GM. In the recently concluded fourth quarter of fiscal 2014, GM’s market share in China increased by 0.6%.  GM’s market share growth is due to the strength of the company’s Cadillac, Buick, and Wuling brands. Global Cadillac sales increased 5% on the back of a 47% increase in China, bringing the cumulative sales growth of the brand to 35% since 2012. Chevrolet also achieved a record sales figure as volumes of the new Trax crossover gathered steam. Crossover and SUV demand in China is expected to grow at about a 10% annual rate and reach about 7 million units by 2020. [1]

GM is now looking at the luxury car segment in China, since it already has a significant presence in the mainstream car segment. Last year, GM got the government’s approval to build a $1.3 billion plant with a capacity to produce 150,000 units of Cadillac cars locally. With more competitive pricing, GM is targeting a 10% market share in the Chinese luxury market by the end of the decade. As the proportion of the higher priced vehicles increases, average income earned per vehicle could rise even further.

Cadillac Revival

In 2014, three of GM’s four main brands did really well, with sales of Chevrolet, GMC, and Buick increasing by 4.4%, 11.3%, and 11.4% respectively. However, sales of Cadillac, GM’s luxury brand, fell by 6.5%. Operating a successful luxury brand is highly important for an auto company since luxury companies contribute about 20% in revenues and about 33% in profits despite contributing less in sales. In order for GM to raise its profitability, it is imperative that it revives Cadillac sales in the U.S. and China.

To do so, the company is focusing on two specific areas: First, the company will invest $12 billion into eight new Cadillac models, which it plans to bring to the market by 2020. [2] Three of those vehicles are expected to be SUVs. Luxury SUVs was the fastest growing car segment among all car segments in the U.S. in the year 2014, having grown at 14.2% compared to 2013. [3]  GM, which has long been known for making excellent full-size pick-up trucks and SUVs, has only one vehicle representing it in the segment: CRX. Recently, Cadillac president Johan de Nysschen told the media at the North American International Auto Show that the Cadillac  brand would put a strong emphasis on the crossover SUV segment. [4] Compared to Cadillac’s solitary offering in the segment, BMW has five vehicles in the segment, while Audi has three.

Second, the company plans to increase offerings from its Cadillac brand in China and start producing Cadillacs in China. GM estimates SUV sales to account for 7 million units in China by 2020, more than thrice the current size of the segment. Similar growth is expected in luxury sales, which are expected to comprise nearly 10% of the market by 2020. [5] To this end, GM responded by starting the production of its full-sized sedan, Cadillac XTS, in Shanghai in 2013. The company also plans to build 95% of its Cadillac vehicles in China by 2018. [6]  GM plans to keep adding one new locally produced Cadillac brand to its portfolio through 2016. The automaker sold more than 73,000 Cadillacs in China in 2014, representing a 51% increase. It expects annual sales of the brand to reach 100,000 by 2015 and capture 10% of the luxury market by 2020. [7]

Underfunded Pension Plans

GM needs to shore up its underfunded pension plans in order to lower its financial obligations. Competitor Ford has increased its cash contribution to pension funds by $9 billion, thus bringing down its underfunded status from nearly $19 billion in 2012 to $9 billion at the end of 2014. However, General Motors did not follow suit. As a result, its underfunded pension obligation had increased by nearly 20% to around $24 billion by the end of 2014. However, reducing its pension obligations will prove tougher now given the $5 billion stock buyback and 20% dividend increase it announced recently. Over the next two years the company is expected to spend around $18 billion in investments and might have to spend some amount on meeting litigation related liabilities or out of court settlements related to its handling of the ignition switch issue.   However, reducing its pension obligations will make the stock far more attractive to investors and this should be high on its priority list in the coming year.

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Notes:
  1. China And Other Emerging Markets To Drive SUV Demand, China Economic Review, February 2014 []
  2. GM to Spend $12 Billion to Fund New Cadillac Models by 2020, Bloomberg, January 2015 []
  3. Auto Sales, Wall Street Journal, January 2015 []
  4. GM to Spend $12 Billion to Fund New Cadillac Models by 2020, Bloomberg, January 2015 []
  5. GM To Pump $12 billion In China, Hike Capacity 65%, Autonews, April 2014 []
  6. Cadillac to Build 95% Cars Locally by 2018 for China Push, Bloomberg, December 2014 []
  7. GM Ramps Up China Strategy, Wall Street Journal, October 2013 []