General Motors (NYSE:GM) shares have been drawing quite a bit of interest from investors recently. Part of the reason is that GM's bottom line is showing signs of growth, and the stock looks cheap at just 4.1 times earnings.
But plenty of investors are also drawn to GM's dividend. The General has paid out $1.48 in dividends over the last four quarters, giving it a dividend yield of about 4.6% at current prices.
That's a hefty yield. But can GM keep paying out at that rate if the economy turns down? Like all automakers, GM is a cyclical business. Because of its huge fixed costs (all those factories, all that tooling), GM needs a certain level of auto sales just to break even. As the market gets above that level, GM's profits grow.
GM's profits have been very strong lately, because sales (particularly in the U.S. and China) have also been strong. While GM dipped deep into the red during past recessions, posting hefty losses, it is less likely to fall into losses during the next downturn. Its balance sheet and cost structure are both far healthier than they used to be, and CEO Mary Barra has done a great job of preparing GM for rainy days to come.
However, it's still a safe bet that GM's profits will get squeezed when (not if) the U.S. enters its next recession. That raises an important question for investors considering GM because of its dividend yield: Will the company be able to sustain those divided payments through an economic downturn?
Why GM's cash reserve is an important part of this discussion
It turns out that Wall Street analysts have been asking the same question -- and one of them, Brian Johnson of Barclays, asked about it during last week's earnings call.
Before we look at that discussion, here's some background: One of the problems that automakers (including GM) have faced in past downturns is the need to cut back spending on future products as profits have swung to losses.
During the 2008-2009 economic crisis, Ford (NYSE:F) was one of the few automakers that was able to continue aggressively funding its future-product programs, because then-CEO Alan Mulally had raised over $20 billion to fund Ford's turnaround in 2006. That put Ford in the happy position of being one of the few automakers to have impressive new products at its dealerships once sales started to recover a few years later. Strong sales and profit gains were the result.
The industry has learned its lesson from that experience. Most major automakers are now committed to maintaining cash reserves to fund new-product development during the next downturn. GM has said that it plans to maintain a cash reserve of $20 billion in order to continue to fund new-product development during a downturn. As of the end of the second quarter, GM had $20.1 billion in cash and another $14 billion in available lines of credit.
What GM's CFO said about dividend payments during a future recession
The gist of Johnson's question to GM's chief financial officer, Chuck Stevens, during the earnings wall was this: Will GM continue to pay the dividend even if it's drawing down that cash reserve during a future downturn?
Here's how the conversation went.
Brian Johnson: "Thinking ahead to a potential eventual downturn, what is your commitment to the dividend that you're paying now? You didn't buy back stock in part, we understand, because you wanted to maintain a $20 billion cash balance. But in a downturn, that might go down. Just how committed are you to the dividend through a downturn? Or would you seek to maybe limit the dividend and focus more on share buybacks?"
GM CFO Chuck Stevens: "I think that's a hypothetical question, Brian, because it depends on the downturn, the depth of the downturn, the perspective on the view of the downturn. Clearly, as we think about a moderate downturn and we think about our cash balance and everything else, what we would like to be able to do in a typical moderate downturn, maintain investment and maintain the dividend without drawing on [GM's $14 billion revolving line of credit]. If those are the facts and circumstances at that point, I think that would be a guiding behavior or a guiding tenet that you can think about. But it really depends on the facts and circumstances of the downturn."
Johnson: "[When you say] 'kind of moderate,' are you thinking minus 10%? Minus 20%? Minus Great Recession numbers?"
Stevens: "Well, Great Recession isn't moderate. So I would say, if you look historically and from a U.S. perspective, a moderate downturn is 20% to 25%."
Johnson: "You would be willing to have cash go below $20 billion and use the balance sheet cash [to maintain investment and maintain the dividend]?"
Stevens: "That's why we have it."
The upshot: GM considers the dividend a priority -- up to a point
Stevens' point about the impossibility of predicting the severity of a future recession is well-taken. There's obviously no guarantee that GM's board of directors will be willing to continue paying a dividend through a severe downturn.
But it seems clear that the company considers the dividend a priority and it will try to sustain its payments to shareholders through the next downturn, even if it's drawing down its cash reserve to fund investments in future products. That said, if things get really bad and GM is forced to draw on that $14 billion line of credit, the dividend might get cut until conditions improve.
Speaking as a long-term-minded GM shareholder, that sounds like the right balance.