A day after General Motors (GM 2.69%) announced a massive restructuring that will likely eliminate over 14,000 jobs in the U.S. and Canada, analysts and pundits are asking: Why? Why does GM feel the need to idle or close seven factories now, when sales are still strong and the economy seems to be in decent shape?
As my Foolish colleague Adam Levine-Weinberg noted, this restructuring has an obvious goal: to boost GM's free cash flow.
During a conference call on Monday, CFO Dhivya Suryadevara said that GM expects its annual "adjusted automotive free cash flow" to rise from about $4 billion in 2018 to roughly $10 billion by the end of 2020 -- a quick payoff for a restructuring plan that will cost about $2 billion in cash to implement.
But again, why do this now? And why did GM make the choices it made? I think the answer boils down to three related reasons. Let's look at each.
Reason No. 1: GM is worried about a recession
First, we should note that auto sales are cyclical: They rise and fall with consumer confidence, which closely follows economic cycles. Automakers might sell as many as 17 million "light vehicles" (the industry term for cars, pickups, and SUVs) in a good year in the U.S. But during a recession, the pace of auto sales could drop to 12 million a year, or even lower.
That doesn't sound like the end of the world, does it? But consider: GM, like every automaker, has high fixed costs. Its factories and tooling and labor contracts cost a lot of money, no matter how many vehicles it's selling at any given moment. A sales decline that seems incremental can have an outsized impact on its profit margin.
Historically, big automakers often swung to losses for several quarters during recessions. A priority of GM's post-bankruptcy restructuring was to lower its so-called "break-even" point, the pace of U.S. auto sales at which it would break even, to between 10 and 11 million a year. (That's for the whole U.S. light-vehicle market, not just for GM.)
For context, at the very bottom of the Great Recession, the pace of U.S. light-vehicle sales was around 9 million a year.
Suryadevara said on Monday that this restructuring will lower GM's break-even point even further, possibly enough to keep it profitable even through a severe or protracted recession.
Why now? Because the current U.S. expansion is very, very old by historical standards, and a recession seems likely sooner rather than later. On top of that, GM is taking a big hit from the Trump Administration's tariffs on steel and aluminum: About $1 billion in added costs in 2018.
Why is GM so concerned about staying profitable through a recession?
Reason No. 2: GM wants to lead in future technologies
GM has an aggressive electric-vehicle development program under way. It's creating all-new architectures for a series of electric vehicles that will start to show up at dealers in about four years. At the same time, GM is also spending a lot of money -- $1 billion this year, more next year -- to develop self-driving cars via its GM Cruise subsidiary.
Barra is aiming to position GM as a long-term leader in both technologies. So far, so good: GM's electric Chevrolet Bolt was the first long-range mass-market-priced vehicle (beating Tesla's Model 3 to market by several months), and GM Cruise expects to begin deploying self-driving taxis in U.S. cities next year.
Simply put, if the next recession forces GM to cut its spending, it risks falling behind rivals. Taking action now to boost cash flow, and to lower GM's break-even point, should help it keep these important -- and expensive -- programs fully funded.
Why did GM make the decision to close five factories?
Reason No. 3: These factories weren't profitable
GM said it will idle five factories in North America. Three of those are "assembly plants," meaning they produce finished vehicles. Together they employ about 5,700 of the roughly 6,300 hourly workers affected by the restructuring. (The remaining two factories are smaller facilities that make transmissions.)
It's likely that all three of those factories are unprofitable, or soon will be. A general rule of thumb is that an auto factory breaks even when it's running at about 80% of "capacity," which is generally defined as two 8-hour shifts, five days a week. But with sedan sales falling, these factories -- which make sedans -- have had their production cut.
One of those factories, GM's Lordstown Complex in Ohio, builds the compact Chevrolet Cruze sedan. Look at what has happened to Cruze sales over the last five years: They've fallen by more than half.
The upshot: Lordstown is currently operating on just one shift, and it's almost certainly losing money. It's a similar story at the other two assembly plants, and at the transmission factories that support them.
The upshot: It's about keeping GM on course
To sum up: GM wants to ensure that it can continue to fund its future-product and advanced-technology programs through the next recession. In order to boost its cash flow and lower its break-even point, it's eliminating unprofitable models from its North American lineup, idling the (also unprofitable) factories that make them, and cutting salaried workers, including executives.
That's the answer.