I've been pretty skeptical of General Motors (NYSE:GM) for most of the past year and a half. The company's redesigned Chevy Silverado and GMC Sierra full-size pickups didn't sell very well compared to Ford's (NYSE:F) F-Series trucks in late 2013 and early 2014. Additionally, the Cadillac brand has lost its momentum in the past year. On top of that, the ignition-switch recall issue has been getting worse, not better.
That said, General Motors is on track to post significantly better performance in 2015 and beyond. However, its stock price doesn't reflect its future earnings power. Accordingly, I loaded up on GM shares last week.
Revitalized U.S. vehicle portfolio
China has overtaken the U.S. as GM's biggest market, but the U.S. is still GM's profit machine. Today, the U.S. represents less than 30% of GM's total unit sales and all of North America accounts for a third of GM's unit sales. However, North America accounts for about $100 billion in annual revenue and nearly all of GM's profit.
Luckily, conditions are looking very favorable for General Motors in its home market. Since spring 2013, GM has launched redesigned versions of its full-size trucks and large SUVs: the Chevy Silverado, Suburban, and Tahoe; the GMC Sierra, Yukon, and Yukon XL; and the Cadillac Escalade and Escalade ESV.
These products have significantly higher average transaction prices and margins than GM's corporate average. Moreover, GM is the runaway leader in the large SUV market and is neck and neck with Ford in the full-size truck market.
Since the launch of the new large SUVs earlier this year, GM has seen strong demand. Through the first nine months of 2014, GM grew its share of the U.S. large SUV retail market by 10 percentage points to a stunning 78%.
In the last six months, combined sales of GM's large SUVs have soared about 30% year over year to nearly 145,000 units. Retail performance has been even better -- for example, sales of the GMC Yukon and Yukon XL were both down in October, but retail deliveries of those models increased 49% and 51%, respectively.
Additionally, after getting off to a slow start in 2013 and early 2014, GM's redesigned full-size trucks have sold well in recent months. Combined sales of the Chevy Silverado and GMC Sierra are up 12% year over year for the last six months.
Much of these gains has come at the expense of top rival Ford. In 2013 and early 2014, Ford had been running its truck plants at full capacity. However, Ford is now in the midst of an ambitious transition to the new aluminum-bodied 2015 F-Series trucks.
This has forced Ford to take weeks of downtime at its truck plants for retooling. The changeover is thus reducing F-Series production by about 90,000 units. So far, Ford has only completed the changeover at one of its two truck plants -- the other changeover will occur in early 2015. Thus, GM should be able to continue gaining market share in the first half of next year.
Falling gas prices could further boost demand
The downside of GM's reliance on full-size trucks and large SUVs for much of its profit is that they get poor gas mileage compared to cars and small crossovers. However, gas prices have fallen dramatically in recent months, which is starting to reawaken Americans' appetites for big vehicles.
As of last Monday, U.S. retail gasoline prices had fallen for 46 consecutive days. The average price fell a total of $0.42 per gallon over that time period, according to AAA. As of Wednesday, U.S. retail gas prices averaged $2.92 per gallon.
Gas prices have been paralleling a substantial decline in crude oil prices. On Wednesday, Brent crude oil prices fell below $80 per barrel -- equivalent to about $1.90 per gallon -- for the first time since September 2010. Furthermore, the U.S. Energy Information Administration recently opined that gas prices are likely to stay (relatively) low for the foreseeable future.
The EIA expects retail prices for regular gasoline to average just $2.80 per gallon in December. Furthermore, the EIA projects that Brent crude will average $83 per barrel in 2015. The result is that regular gasoline prices, which averaged $3.51 per gallon in 2013, could fall to $2.94 per gallon next year.
In addition to boosting demand for full-size trucks and large SUVs, low gas prices will also help GM in its pickup market-share battle with Ford. Ford invested heavily in the new aluminum-bodied 2015 F-Series trucks in order to boost their gas mileage. However, a small fuel economy deficit to Ford won't hurt GM much if gas prices remain around (or below) $3.
Cleaning up its international messes
While the profit picture in the U.S. is improving, it's equally important for GM to improve its results abroad. Sales growth in China has slowed recently, with sales rising just 3.2% last month. Still, sales are up 10.7% year-to-date and GM's share of its joint venture's earnings in China exceeded $1.5 billion through the first three quarters of 2014. China is still a solid performer.
On the other hand, the rest of GM's international markets have been losing money on a combined basis. The biggest losses have come in Europe, where GM has already lost about $1 billion this year.
GM expects to improve its pre-tax earnings in Europe by about $1.5 billion between 2014 and 2016, returning to profitability in the process. The biggest savings will come from completing the European restructuring process. That will lower GM's fixed costs while also ending a period of high restructuring expenses for severance, accelerated depreciation, etc.
GM also expects the European market to grow and it hopes to gain some market share as it updates its product portfolio. GM has particularly high hopes for redesigned versions of its Opel Corsa and Opel Astra, which will be released in the next year. These two vehicles account for half of GM's sales volume in Europe, and the new versions are expected to be much more profitable.
Elsewhere in the world, GM is winding down manufacturing in Australia by 2017. Last year, GM estimated that it cost nearly $3,500 extra per vehicle to build cars in Australia. By moving that production to larger, more efficient plants elsewhere in Asia, GM will significantly improve the profitability of its international operations.
Plenty of room for error
GM's goal is to boost its global operating margin to 9%-10% by early next decade. Depending on the pace of sales growth, that would raise annual pre-tax profit to $15 billion-$20 billion. By contrast, the whole company is valued at about $50 billion today. This means that there's a lot of room for things to go wrong without damaging the case for investing in General Motors.
In the last few years, GM has shown good discipline about fixing supply-and-demand balance problems by reducing costs and cutting capacity, rather than rolling out huge discounts to sell cars that people don't really value.
As long as GM continues to maintain that discipline, it should be able to address any demand weakness long before it threatens the company's viability. In the meantime, General Motors can ride the tide of rising demand for high-margin trucks and large SUVs to big profits in the next few years.