Earlier this week, General Motors (NYSE:GM) announced that it will spend $1.4 billion on a massive expansion of a factory in Arlington, Texas, that builds its largest SUVs.
GM's Arlington factory cranks out Chevrolet Tahoes and Suburbans, GMC Yukons, and Cadillac Escalades on three busy shifts. Work on the factory expansion, which will begin this summer, is not expected to disrupt the current production line.
That's a good thing, because right now that factory is straining to keep up with demand. But will demand for GM's largest SUVs last long enough for this $1.4 billion bet to pay off?
A substantial expansion of a very busy factory
Over the next three years, the plant will receive a variety of upgrades that will add about 1.2 million square feet to its current 4.4 million square-foot footprint. The plant will get upgraded paint and body-assembly facilities, along with "general assembly area upgrades," GM said in a statement.
GM said that the upgrades will allow it to "more competitively produce high-quality full-size SUVs." Some of these things are good long-term investments even if demand for the big trucks falls somewhat -- high quality helps to ensure strong pricing power.
Still, it's a significant expansion of the plant, which suggests that GM is planning to increase production of the big SUVs. That's not a surprise, given that the plant is already running at full speed.
But three years is a long time in economic terms. Is a big investment in big truck-based SUVs really wise right now?
Sales aren't soaring, but that may be misleading
At first glance, sales of GM's big SUVs don't appear to be soaring. U.S. sales of the Tahoe and its siblings were up a combined 2.1% in the first half of 2015 -- trailing the overall U.S. market's 4.4% gain.
But that figure is probably misleading. Last month, GM said that it was prioritizing retail deliveries of its large SUVs (or put another way, cutting back fleet sales) because of "strong demand and low inventories."
In other words, GM's dealers could probably sell more of these big SUVs -- if they could get them. But with the Arlington factory already running at maximum capacity, GM has no easy way to make more.
GM's big SUVs were all new for the 2015 model year. They began arriving at dealers early in 2014. Reviews were strongly positive: The new SUVs don't look a lot different from their predecessors, but the changes under the skin were major. Sales have been brisk.
As a group, sales of GM's big SUVs were up about 18.5% last year. And better yet for GM's bottom line, sales of the more profitable GMC Yukon (up 47% in 2014) and Cadillac Escalade (up 54.7% last year) rose by much wider margins.
That's significant. These are all massively profitable vehicles for GM.
Big profits are driving this big investment
A 2015 Chevy Tahoe starts at $46,300, about $20,000 more than the Silverado pickup it's based on. And a fully loaded Escalade -- which is the same size as the Tahoe, shares many of the same parts, and is built on the same assembly line in Arlington -- can break $95,000.
There's a lot of profit for GM in both of those vehicles, and in all of their siblings. Clearly, there's a lot of incentive for GM to build as many as it can sell. And while full-size truck-based SUVs sell in much smaller numbers than they did a decade ago, GM has a commanding share of what's left of the market -- about three-quarters.
Given the strength of the current product line, that's unlikely to change.
The upshot: A gamble for GM -- but probably a good one
Adding new factories and assembly lines is always a risky move for a U.S. automaker. Too often in the past, GM and its rivals have expanded their production capacity during good times, only to see those factories standing idle when economic conditions and consumer tastes shift.
Will these big SUVs still be big sellers three years from now? Nobody knows for sure. But GM has probably made a good bet here. The upgrades to Arlington won't just expand its capacity, they'll also help ensure top-notch quality for future versions of the big SUVs.
That will help ensure that GM can get strong prices for its biggest SUVs in the future -- regardless of demand. And that means this investment is very likely to pay off, in time.