Why GM Cannot Afford To Ignore Cadillac Any More

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Even though General Motors (NYSE:GM) sells almost as many cars as Japanese auto maker Toyota Motors, it makes far less in profits than the latter. For example, for the quarter ended March 31, 2015, GM’s adjusted earnings before interest and taxes (EBIT) were $2.1 billion on revenue of ~$36 billion, while Toyota’s EBIT stood at $5.3 billion on revenue of $59.5 billion. Even though the units sold by both companies weren’t far apart (2.4 million for GM vs 2.54 million for Toyota), their reported revenues differed by nearly $23 billion. This means that Toyota’s average unit price per vehicle sold is roughly $23,400 compared to $15,300 for GM. The puzzle that these facts immediately raise, is what is Toyota doing differently compared to General Motors?

If one were to write a cheat sheet named How To Make Profits While Selling Cars based on trends of the past few years, the following items would be on the list:

1) Sell lots of SUVS and trucks in the U.S.,

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2) Keep your business as small as possible in Europe and South America,

3) Have a successful luxury vehicle brand (or two or three) and,

4) Don’t keep your pension plans underfunded.

(Another item that might soon be added to the list: convince the world that you’re a genius, so that they’ll give you money at really low costs for really far-fetched ideas, but that’s still in the future.)

GM manages to do only the first of these four items. It makes huge losses in its European and South American operations and so far has only ideas about how to make money with its luxury brand Cadillac.  Toyota does three of four and is inching ever closer to doing all four in the near future. Naturally, this means that there is pressure on GM’s management to work on these aspects of its business. In this article, we take a look at a scenario in which GM operates a successful luxury brand.

We have a $38 price estimate for General Motors, which is about 5% higher than the current market price.

Cadillac’s Importance To GM

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. 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. [1] 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 2014, having grown at 14.2% compared to 2013. [2]  GM, which has long been known for making excellent full-size pick-up trucks and SUVs,  has the Escalade in the full-size luxury SUV segment, and the SRX in the mid-size luxury SUV area.  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. [3] Compared to Cadillac’s 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. [4] 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. [5]  GM plans to keep adding one new locally produced Cadillac brand per year 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. [6]

Contribution to Bottom Line

In 2014, GM sold roughly 264, 000 units of Cadillac, which represented a 5% year-on-year increase for the brand. Most of that growth came from China, where sales grew from 50,000 units in 2013, to 73,000 units in 2014. In 2015, China sales are expected to grow to 100,000. Since GM does not break out earnings figures separately for the Cadillac, we’ll have to make some assumptions in estimating the impact of Cadillac to the company’s bottom line. In 2014, GM’s average revenue realized per vehicle sold was around $15,900. The industry average revenue realized per luxury vehicle sold is roughly twice that of other vehicles. Using the same standard for GM, we get an average revenue realized per Cadillac sale of $32,000. This means that GM realized around $8 billion in revenues from Cadillac sales in 2014, or 5% of revenues. This is far lower than the industry standard, where luxury sales, even though making up only 10% of overall units sold, contribute 20% to revenues. It is evident that this an area where GM still has a lot of work to do. Applying similar assumptions to cash profits — average cash profit realized per luxury vehicle is roughly 3.3 times that of other vehicles — we get cash profits from Cadillac of roughly $1 billion. Overall cash profits for the company stood at $11.6 billion in 2014. The contrast is staggering: even though Cadillac sales only make 3% of units sold by the company, they contribute close to 9% of the profits. Increasing the number of units sold should therefore improve the company’s bottom line at a far higher scale than improving sales of any other brand or any geography.

In our model, we have forecast GM’s revenue to grow from $158 billion in 2014 to $193.2 billion by the end of our forecast period. This forecast encodes Cadillac sales of around 400,000 units. However, if the company can increase Cadillac sales to roughly 5% of overall sales by that period, or 600,000 units, owing to the additional profitability of the brand, it can increase its cash profits by $2 billion or 25%. That is an enormous amount, and it clearly shows why the importance of Cadillac cannot be understated by the company any more.

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