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Morningstar | GM Analyst Day Optimism Sends Stock Soaring; We Continue to Think the Stock Is Cheap. See Updated Analyst Note from 11 Jan 2019

GM's stock rose on Jan. 11 at times by nearly 9% after it announced 2019 guidance at a New York analyst day. We had been modeling 2019 adjusted diluted EPS of $6.39, well above consensus of $5.86, because of GM's ability to keep realizing more scale and its fresh light truck offerings in the U.S., so the guidance results in only a $1 per share increase in our fair value estimate to $47. For 2019 GM expects adjusted automotive free cash flow, which excludes the Cruise autonomous vehicle business, of $4.5 billion-$6.0 billion, up from $3.4 billion in 2018 including a discretionary pension contribution. GM guides for adjusted diluted EPS of $6.50-$7.00, and we now model $6.54. The stock also reacted favorably to GM saying it will exceed its 2018 EPS guidance given on Oct. 31 of $5.80-$6.20. GM reports results on Feb. 6.

We have long argued GM has more economies of scale to realize as it consolidates manufacturing down to five global architectures next decade and builds up GM Financial. We also expected robust light truck contributions in 2019 from the new generation full-size pickups launched last August and new Cadillac crossovers such as the XT4 already out and the XT6 due this year. We were pleasantly surprised at GM's optimism for 2019 given macroeconomic uncertainty from U.S. autos being late in their cycle and tariff risk. Risks include whether GM's expectation of U.S. industry sales in the low 17 million unit range holds and headwinds from an SUV plant shutdown this year, but cost savings from the November restructuring announcement and fairly new crossovers are expected to more than offset these risks.

GM's 2019 annual dividend will again be held flat at $1.52 per share, which does not surprise us. We've long expected the dividend to be kept at a level that is sustainable in a recession, which means at times no growth. Buybacks will still be done within GM's existing framework of targeting $18 billion in automotive cash and reinvesting in the business.

Other developments from the analyst day came around GM's $4.5 billion of cost reductions by the end of 2020 announced on Nov. 26 and around EVs and Cadillac. The $4.5 billion from GM North America's likely plant closures will come roughly evenly from salaried staffing reductions, manufacturing efficiencies, and product eliminations of unpopular car models. Cadillac will be GM's leader for all electric, or BEVs, going forward when GM's new battery architecture debuts early next decade. Cadillac will get the first model using the new battery. We think this is being done because it allows GM to charge more for an EV and with the new lower cost battery platform GM thinks it can sell these vehicles at scale and at a profit by then. We also think Tesla's commercial success is a factor, and we see no reason why Cadillac cannot have a desirable BEV to rival Tesla.

GM China will also play a big role in the firm's BEV rollout given the Chinese government's new energy vehicle (NEV) requirements. GM China will launch over 20 new or refreshed vehicles this year and have 10 NEVs by 2020. Management expects Chinese industry demand to be flat from 2018 levels at nearly 27 million units. GM did quite well in China last year, however, because Cadillac continues to grow at double-digit rates there. The brand's 2018 sales of 205,605 rose 17.2% from 2017, bucking GM China's overall decline of 9.8%. This favorable mix shift drastically eases the pain of large volume declines in smaller Chinese cities and keeps GM's cash equity income at nearly $2 billion annually. GM China equity income in the first nine months of 2018 is up 13.7% year over year to $1.67 billion despite Chinese industry sales slowing.

We liked hearing from CFO Dhivya Suryadevara that the long-term goal is to convert nearly 100% of adjusted net income into adjusted automotive cash flow. We calculate the ratio was 53% in full-year 2017. The nearly 100% target is great to hear but will be tough given the capital intensive nature of the business. It's important to note though that GM expects its capital expenditure annually to decline after 2020 to about $7 billion from about $8.5 billion presently. We model on average about $7.4 billion for 2020-22 for conservatism. 2019 capital expenditure guidance is a range of $8 billion-$9 billion and we model $8.5 billion. Better cash flow is a reasonable expectation from investors given last year's GM Korea restructuring and the November GM North America restructuring announcement as discussed in our Nov. 26 note.

GM Financial will also keep paying the parent company a cash dividend, which it started to do in fourth quarter 2018. The captive to us is a hidden asset so to speak because it is still ramping up to be a mature full-service captive finance arm following GM acquiring AmeriCredit in 2010. The captive is guided to generate pretax income of about $2 billion annually once it reaches steady state next decade, up from about $800 million in 2014. For the first nine months of 2018, the unit's earnings are up 65% year over year to $1.48 billion.

Management remained fairly quiet on its long-term plans for the Cruise AV unit. Cruise CEO Dan Ammann, formerly GM's president, stressed it makes the most sense from a synergy perspective for now for Cruise to remain part of GM. We still think it's too early to spin-off Cruise given it just got its first revenue in January (licensing to minority owner Honda), but we wouldn't be surprised if GM eventually separates the unit in an attempt to maximize shareholder value. At the analyst day, GM reiterated its plans to launch ride-hailing this year but did not get more specific than that. We expect the first city to be San Francisco, where Cruise continues to test extensively. A video shown at the analyst day, also available on the Cruise Automation YouTube channel, showed impressive autonomous driving in San Francisco in complex conditions such the same pedestrian jaywalking in front of GM's AV multiple times and blind left turns.