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Morningstar | GM's North American Restructuring Shows the Firm Moving More Toward What It Does Best

We are raising our GM fair value estimate to $46 after incorporating a major restructuring for GM North America announced Nov. 26. In our view, the company is wisely staying ahead of the cycle and moving to remove vehicles that are out of favor now that Americans are buying light trucks at a torrid rate. Light trucks constitute nearly 70% of monthly U.S. industry sales, and in GM's case that ratio is about 80%. That ratio is why we think GM stopping production in March and June of 2019 of the Buick LaCrosse, Cadillac CT6, Cadillac XTS, Chevrolet Cruze, Chevrolet Impala, and Chevrolet Volt, all of which we calculate made up just 9.4% of GM's U.S. sales volume year to date (through October), makes sense. GM will stop allocating product to three GMNA plants next year in Oshawa, Ontario, Lordstown in Ohio, and Hamtramck in Detroit. It will also end production at two U.S. transmission plants. As of now, GM is not saying it will close these plants and permanently end production of these vehicles, but we think the CT6 and maybe the Volt will be the only ones to remain in existence, if any, and if kept they would move to a different plant.

Management expects $6 billion of additional free cash flow by the end of 2020, a substantial amount in our view, with $4.5 billion of that from cost reductions and $1.5 billion from capital expenditure reductions as more global vehicle architectures are rolled out. The company seemed hesitant on an analyst call to say if the $6 billion is gross or net, and only said there's puts and takes on that number based on macroeconomic conditions. Multiple times on the call management stressed more detail will be provided around breakeven levels, GMNA operating margin, and sustainable free cash flow generation at a Jan. 11 investor day in New York. The restructuring will entail pretax charges between $3.0 billion and $3.8 billion, and be mostly special items with the majority recorded in the fourth quarter of 2018 and first quarter of 2019.

Up to $2 billion of the $3.0 billion-$3.8 billion will be cash charges as GMNA reduces salaried headcount by 15%, and up to $1.8 billion will be noncash impairments and pension charges. GM will take out a supplemental line of credit to pay the cash charges but expects to pay off this debt quickly since it expects a payback on the spending of under one year. The vast majority of the actual cash outflow will be complete by the end of 2020. GM will also close two plants outside North America by the end of 2019, which we speculate could mean more plant closures in Korea. India, where GM only produces for export, is also possible in our view.

GM is becoming more focused on selling light truck models and also electric and autonomous vehicles. We like that the midsize Malibu was left off the list because with FCA and Ford exiting this segment we don't think GM needed to as well, and the Malibu has seen favorable commentary from Consumer Reports. GM's Nov. 26 press release said resources for EVs and AVs will double in the next two years. Cost savings will come from more parts sharing, especially in areas not visible by the vehicle owner, more virtual development to save time and costs, integrating the vehicle and propulsion engineering teams, and reducing executives by 25% to facilitate decision-making, which we like to hear. The GEM program for consolidating production for emerging markets is not impacted by this announcement and will start next year.

We think this GMNA restructuring is a bold move and one that Old GM would not have done, as it would have instead relied on once again increasing incentives to move vehicles off dealer lots, which would hurt its profits and its brands' residual values. New GM produces to meet demand and the GMNA restructuring helps the company get more of the scale a firm GM's size should realize while also trimming fat in anticipation of an eventual downturn in the U.S. market.