General Motors Company GM announced Monday it would close or contract seven plants, lay off 14,000 assembly and white-collar workers, and discontinue six vehicle models.
The strategy, which simplifies the corporate structure and redirects resources to more profitable segments, caught some on the Street off guard.
A Welcome Surprise
Morgan Stanley analysts Adam Jonas and Armintas Sinkevicius cited expectations for Ford Motor Company F to restructure before GM, and claimed the shrinking automaker acted “unusually proactive.”
“Typically, auto companies exhaust a range of options on price, financing terms, ‘red tag’ sales, and employee discounts to ‘move the metal’ before capitulating on capacity cuts,” they wrote.
But few are complaining about GM’s haste. Bank of America Merrill Lynch analysts called the impending payback — a $6 billion improvement in annual free cash flow — “impressive.”
“Not only does this indicate the magnitude of dilution from GM’s passenger car portfolio (and potentially other segments) on its total business, but also illustrates GM’s prudence, consistent with actions over the past few years, in optimizing its business towards segments with profit/cash flow opportunity,” they wrote. “More importantly, GM’s plan to lower its fixed cost base should bolster its breakeven level, allowing room for ongoing investment in future businesses (Cruise AMOD, etc.).”
A Prescient Move
Morgan Stanley considers the strategy critical to GM’s sustainability. Now-eliminated vehicles had been losing money with no route to profitability, and analysts had forecasted a 30-percent drop in profit and 75-percent plunge in free cash flow next year.
“We see these steps as necessary to ensuring the long-term sustainability and independence of GM as a leader in Auto 2.0 and a significant employer of US labor,” Jonas and Sinkevicius wrote. “In our view, if GM does not address excess capacity in 2018, they will have to address it in future years. While it may be ‘easier’ to cut capacity in the middle of a recession (when everyone else is doing it, when the industry is losing money, and when bonds are trading below par), we believe the affected workers would likely get a better deal from a stronger GM than from a weaker GM.”
Jonas and Sinkevicius expect all of the savings to be reinvested in higher-growth segments deemed valuable by investors and partners — particularly Auto 2.0. Given the discontinuation of the Chevy Volt, they suspect GM intends to bypass the hybrid powertrain phase and instead go all in on fully electric. Tigress Financial’s Ivan Feinseth added the potential to unlock value in GM’s autonomous vehicle unit, Cruise.
Management implicitly affirmed its focus.
"We recognize the need to stay in front of changing market conditions and customer preferences to position our company for long-term success," Chairman and CEO Mary Barra said in the announcement.
The restructuring is also seen to protect GM’s position in pickups and SUVs.
“This is another sign of GM management’s commitment to shareholder value and long-term viability as a US employer,” Jonas and Sinkevicius wrote.
The restructuring may not get off without a hitch. President Donald Trump already chastised Barra and, in a tone "very tough," expressed his displeasure.
"You know, the United States saved General Motors, and for her to take that company out of Ohio is not good," Trump told reporters.
Morgan Stanley anticipates more severe pushback from political and labor forces, and the resulting headline risk and depressed sentiment “may likely be the highest up-front cost to GM” — even more so than expected market share concessions.
Feinseth forecasts similar headwinds but considers the strategy critical nonetheless.
“While the firing of factory workers and the closing of factories will most likely get a lot of negative pushback from Pres. Trump, I have said that GM would evolve to focus on a much narrower product line of more high-value vehicles,” Feinseth wrote.
Morgan Stanley perceives a higher level of urgency at GM than at rivals, although Ford is expected to follow with similar restructuring plans soon enough.
“For several years now under Mary Barra’s leadership, GM and its Board has acted with savvy and decisiveness to address emerging problems on operations, strategy, and capital allocation,” the analysts wrote. “While the company’s stock price may not appear to give GM credit for such actions, we see them as highly valuable to all GM stakeholders (including labor) long term.”
Bank of America Merrill Lynch maintained a Buy rating and $60 target, and Morgan Stanley maintained an Overweight rating and $44 target. Tigress Financial recommends purchase with a target in the mid-$40s.
GM's stock rose about 6 percent Monday, closing at $37.65 per share.
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