Sales of GM's new-for-2014 Chevy Silverado haven't soared, but the company's profit per truck is believed to be up sharply. Source: General Motors.
Shares of General Motors (GM -0.41%) fell nearly 6% on Tuesday after a sharp downgrade from a leading Wall Street auto analyst.
Morgan Stanley's Adam Jonas cut his price target for GM from an already-bearish $29 to $27, saying the automaker faces the same pressures that drove rival Ford (F 0.22%) to lower its guidance last week.
GM's response? As if to say that it wasn't worried, the company declared a $0.30 fourth-quarter dividend on Wednesday morning.
So is Morgan Stanley's downgrade justified?
"We're not waiting for GM to warn"
As far as concerns about GM's near-term outlook go, Jonas' thesis is pretty simple: Ford cut its estimates because of worries about recall costs, South America, and Russia. All of those things apply to General Motors, too; therefore, expectations should be lowered for GM as well.
Like Ford, GM held a full-day briefing for investors last week. But unlike Ford, GM didn't use its briefing to guide investors' near-term expectations downward. Instead, the General's senior execs reaffirmed the company's near-term financial targets, and then talked in detail about future products and initiatives to improve profitability and competitiveness over the next several years.
That was good stuff, and all important. Clearly, and understandably, CEO Mary Barra wants to get investors refocused on the company's growth story after months of dismal recall news.
But as Jonas sees it, a warning might have been appropriate -- so he did it for the automaker.
In a tough but sympathetic note titled, "We're Not Waiting for GM to Warn," Jonas and his team laid out their case: The factors that are pressuring Ford's earnings, plus what they see as a U.S. auto market that might be set to stall, justify a significant cut in expectations for GM.
Are they right?
A downgrade built on some pessimistic -- and disputed -- assumptions
Any estimate of a company's future performance starts with some assumptions. And several of the assumptions built into Jonas' price target are markedly pessimistic. He acknowledged that his is an outlying view: "Our estimates are well below [Wall Street] consensus. 20% below in 2015 and 16% below in 2016 to be precise."
He assumed, for instance, that GM's German subsidiary Opel will continue to lose "well in excess of $1bn annually" indefinitely until and unless GM decides to divest it. There's plenty of reason for concern: GM has lost almost $20 billion in Europe since 1999. But the company has an elaborate turnaround plan that is showing good signs of progress, and its current guidance is that its European operation (which is mostly Opel) will return to profitability in 2016.
A key part of the bullish case for GM is the revival of the Cadillac brand. Average transaction prices are up about $4,000 this year, thanks to strong new models like the CTS sedan. More new Cadillacs are expected next year. Source: General Motors.
Jonas asserted that the "U.S. auto cycle is peaking." The analyst has said elsewhere that he thinks cheap financing has "pulled ahead" of demand -- in other words, low interest rates have helped U.S. auto sales boom prematurely relative to the rest of the economic cycle.
Whenever U.S. auto sales peak, we can expect automakers' profit margins to erode as they compete more aggressively (with incentives) for a dwindling pool of buyers. There has been little evidence of that so far, but Jonas thinks it's coming soon.
That in turn affected his estimate of GM's future operating profit margins in North America, by far its most important region. While GM said last week it expects a margin in the 9% to 10% range by 2016, Jonas forecast a margin of 7.2% in 2016 and 5.8% in 2017.
To be very clear, Jonas' view of the U.S. auto market is disputed. Earlier this year, analysts at TrueCar built a complex model of the U.S. auto market that not only took into account the potential for "pulled ahead" demand, but also looked at how the last recession might have affected current demand for new vehicles, and a host of other factors.
Based on that model and the observations he has made since it was built, TrueCar Vice President Eric Lyman told me last week that he believes the U.S. auto market still has plenty of room to grow, and isn't likely to peak until roughly the second quarter of 2017.
If Lyman is right -- and the evidence doesn't (yet) say he's wrong -- that alone would support a much more bullish case for GM over the next couple of years.
Jonas is probably right that the pressures hitting Ford in Russia and South America will affect GM as well. But the question is, hasn't GM's management already taken those into account?
This isn't the GM of old, where the company's left hand was famously oblivious to what its right hand was doing. This GM has sharp management and much more effective internal financial controls. Its guidance should be taken just as seriously as that at any other well-managed company. Some skepticism is always warranted, but a good management team will strive to underpromise and overdeliver.
Barra and team did say earlier this year that pressures in South America would weigh on the company. But they said nothing last week that changed the company's most recent 2014 guidance, which was this: Excluding the costs of the recall scandal, GM expects its pre-tax earnings to come in somewhat ahead of the $8.6 billion it earned on the same basis last year.
So whom do you believe?
The upshot: This could be a buying opportunity
In one corner, we've got one of Wall Street's sharpest auto analysts. In the other, GM's management team. Each is offering a sharply different view of the company's near-term prospects.
Who's right?
Personally, I'm giving GM management the benefit of the doubt until it is proven wrong. I own GM stock because I think that current leadership is finally -- after decades of mismanagement -- taking the General in the right direction, toward increased, sustainable profitability. I haven't yet seen any reason to abandon that thesis.
What do you think? Is GM in for some rough sailing, or will the skies continue to be mostly sunny for a while longer? Scroll down to leave a comment with your thoughts.
