Will GM's Chevy Silverado maintain pricing power next year? Image Source: General Motors.
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While General Motors is having arguably the worst year in company history in terms of negative press surrounding itstragic recall saga, there are a few reasons to expect that better days are ahead for the troubled automaker. When you boil an investment thesis in General Motors down to the bare minimum, you're basically betting that the company will improve its profits fast enough for its stock price to beat the market going forward.
Despite owning shares in the company, and believing there are indeed better days ahead, I'm growing skeptical about GM's ability to increase its profits fast enough to beat the market. Here's why.
Where's the cash coming from?
First things first: As you may know, despite General Motorsselling more vehicles in China, a decisive amount of its profits come from right here in North America. Here's a quick breakdown of how vast the difference is, from the most recent quarter:
Graph by author. Data source: General Motors Q3 presentation.
With that in mind, if you're betting that General Motors is going to accelerate its profits fast enough for its stock price to beat the market going forward, that profit is going to be generated here in North America. General Motors is aiming to achieve 10% operating profit margins in North America, and that's where I believe the automaker is going to have difficulties.
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Can it be done?
Here's a glance at where GMNA's margins have been and where it needs to go.
Graph by author. Data source: General Motors quarterly presentations.
The good news is that GM has strengthened its operating margins significantly since the recent low in 2012, and remains close to its 10% goal. The problem is getting there and sustaining that level, and an argument can be made that this might be as close as the automaker gets. Consider the following factors.
Full-size trucks, full-size profits
It's no secret that full-size trucks haul in the majority of profits and margins for General Motors, as well as for its crosstown competitor Ford. Fresh products sell better, period, and GM had a full year of its closest competitor selling an outdated design while it released new designs of its Chevrolet Silverado and GMC Sierratrucks. That means General Motors was able to generate some of its strongest pricing power in 2014.
Because of strong pricing with successful SUVs and full-size trucks, GM has recorded 26 consecutive months of average transaction price increases, or ATPs. According to J.D. Power's estimates, General Motors' ATPs were up $790 in November from October, and were up a staggering $3,100 versus a year ago.
Unfortunately, this will change next year as Ford's next-generation 2015 F-150 hits the streets and the automaker slowly accelerates production. Depending on how successful Ford's F-Series lineup is, it could take a chunk out of the Silverado's and Sierra's market share, as well as hindering their pricing power -- which would certainly have an adverse impact on GM reaching 10% margins in North America.
Another factor that could cripple General Motors' chance to reach 10% margins is its Cadillac luxury lineup. According to investor day presentations, luxury vehicles represent about 10% of sales in North America, but those sales are more valuable to automakers and are estimated to account for roughly one-third of the industry's profit.
2016 Cadillac ATS-V. Source: General Motors.
Unfortunately, the story for General Motors' Cadillac in 2014hasn't been a positive tale. Just last month Cadillac retail sales dropped 20% compared to last year. It's been a yearlong trend, as Cadillac's retail sales have slipped 6% through the first 11 months of 2014, compared to the same time period last year. It's the only General Motors brand to post a sales decline for the full calendar year, compared to last year.
Recently, Joseph Spak and his team at RBC Capital Markets expressed concern regarding Cadillac as well: "Turning around a luxury brand takes time, but GM's targets rely on Cadillac, whose profitability may need to shrink before it grows. In NA, Cadillac is being priced on top of strong German competition, which, while admirable, is questionable as the product (while improved) is not comparable."
Now, with those two reasons highlighting the headwind GM faces in expanding its margins in North America, it's still only one part of the story. While I'm skeptical that GM can reach, not to mention sustain, 10% margins here in North America, the automaker is poised to expand profitability in China -- as GM remains one of two foreign automakers that dominate in the region -- and should break even in Europe next year, which if done earlier would have saved billions in bottom-line losses over recent years.
There are still reasons to remain bullish on GM, but if the automaker loses significant ground to Ford in full-size truck market share and can't reverse its slide in luxury sales, investors will want to revisit their investment thesis.
The article Thinking About Buying General Motors? You Might Want to Think Twice originally appeared on Fool.com.
Daniel Miller owns shares of Ford and General Motors. The Motley Fool recommends Ford, General Motors, and Tesla Motors. The Motley Fool owns shares of Ford and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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