Image Shown: Shares of General Motors moved higher after its third quarter 2019 earnings report as investors looked past the UAW strike and towards the future, particularly ongoing cost structure improvements.
By Callum Turcan
General Motors (GM), a holding in both our Best Ideas Newsletter and Dividend Growth Newsletter portfolios, reported third quarter 2019 earnings on October 29. As expected, its results were held down by the UAW strike in the US, which stretched from late in the third quarter (two weeks in September) to early in the fourth quarter (roughly four weeks in October). Please note that General Motors’ fourth quarter performance will also get dinged over the strike. Both sides came together and agreed to a new four-year compensation and benefits package on October 25, which we see as a win-win for both sides. Shares of GM yield ~4% as of this writing.
Strike Aside, Strong North American Performance
The strike cost General Motors $1.0 billion in EBIT during the third quarter. On a full-year basis, General Motors forecasts the strike cost $2.00 in diluted EPS this year. Shares of GM still jumped up over 4% on October 29 as investors turned towards the future, which looks bright. Ongoing strength in North America and a reassurance from management that cost cutting efforts would continue in earnest, even with the commitments made in the recent UAW deal, was welcome news.
In North America, General Motors’ main profit engine, its adjusted EBIT rose by 7% year-over-year to $3.0 billion in the third quarter due to strength in the US pickup market. General Motors’ Chevrolet Silverado and GMC Sierra continue to sell well and take market share in the US, according to the company’s assessment of third-party data. That solid performance offset weakness at General Motors’ international division (weighed down by ever deteriorating performance in China) and modestly higher losses at its self-driving Cruise division (to fund the eventual launch of a commercial self-driving taxicab service). Combined, General Motors’ international and Cruise segment posted $0.4 billion in negative EBIT last quarter. GM Financial saw its EBIT rise by 40% year-over-year to $0.7 billion in the third quarter, aided by the automaker’s strong sales performance in North America and a benign macroeconomic backdrop.
Cost Structure Improvements Still on Track
What likely stood out the most to investors was General Motors’ commitment to keep pushing forward with serious improvements in its cost structure. The automaker revised its year-end 2020 cost savings target down to $4.0-$4.5 billion on an annualized basis due to management opting to transition the Detroit-Hamtramck plant to an electric pickup production plant (instead of closing the facility). Also, the company is moving forward with investments in battery cell production in Ohio. That represents a marginal reduction from previously-targeted annualized operating cost savings of $4.5 billion by the end of 2020. For reference, General Motors’ ‘Automotive’ division incurred $29.9 billion in segment production and operating expenses during the third quarter of 2019 (cost of sales plus SG&A and other expenses).
These savings are coming from the company selling the Lordstown Assembly plant and suspending production at three others including General Motors’ Oshawa Assembly, Warren Transmission Operations, Baltimore Operations in North America. Furthermore, the company is closing a few of its production facilities overseas including one facility in South Korea, along with two others. Readers should keep in mind General Motors exited India’s car market back in 2017 as the company saw no route to profitability in that market under reasonable assumptions. These kinds of big strategic changes are needed to have a needle moving impact.
Salaried headcount reductions, a focus on profitable overseas markets, production base rationalizations, and higher utilization rates at existing facilities represent the company’s main ways of shedding operating costs while maintaining output. Additionally, previously-expected annualized capital expenditure savings of $1.5 billion by the end of next year will likely have to wait in light of the need to transmission the Detroit-Hamtramck plant. CEO Mary Barra noted that the company would spend more on R&D and capital expenditures to support the design and production of electric vehicles over the next five years than on traditional internal combustion engine offerings during the firm’s quarterly conference call.
Since Mrs. Barra took control, General Motors has steadily rationalized its production base and international focus with plenty to show for it. We see General Motors’ guidance post-UAW deal as is a promising sign that its free cash flow enhancing strategy remains on track. General Motors’ noted in its earnings report that:
GM has achieved $2.4 billion in transformation cost savings since 2018, and is on track to realize its 2019 target. As a result of the company’s decision to invest in its Detroit-Hamtramck plant with plans to build an all-electric pickup truck, GM will incur operating costs outside of the scope of its original transformation plan. With this, GM is revising its year-end 2020 cost savings target to $4.0 to $4.5 billion.
Regarding the Detroit-Hamtramck commitment, General Motors already needed to make large investments in electric vehicles to remain relevant in the long run. As the company is targeting electric pickup sales, we think there’s plenty of room here to achieve profitable growth in the medium-term. Unlike the lower margin passenger car market, pickup trucks generally carry generous margins (especially at the mid- and upper-end of the market), and unlike the luxury car market, pickup trucks sell in mass quantities. That in theory should allow General Motors to scale up production to levels that can achieve decent profitability, assuming there’s sizable demand for electric pickup truck offerings which is likely the case.
Concluding Thoughts
Our fair value estimate for GM stands at $48 per share, and we continue to like the automaker in both our Best Ideas Newsletter and Dividend Growth Newsletter portfolios. General Motors’ Dividend Cushion ratio of 3.5x provides for solid payout coverage at a time of trade war volatility, and its Cruise division offers plenty of long-term upside as one of the leaders in the autonomous driving space.
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Callum Turcan does not own shares in any of the securities mentioned above. General Motors Company (GM) is included in Valuentum’s simulated Best Ideas Newsletter portfolio and simulated Dividend Growth Newsletter portfolio. Some of the other companies written about in this article may be included in Valuentum’s simulated newsletter portfolios. Contact Valuentum for more information about its editorial policies.