General Motors: The Big Picture Is Margins

General Motors: The Big Picture Is Margins

Recalls, recalls and more recalls. That’s mostly the story surrounding General Motors Company (NYSE:GM) right now. However, Morgan Stanley analysts think the bigger story is gross margins for the automaker’s North American division. In a report dated May 21, 2014, analysts Adam Jonas, Ravi Shanker and Paresh Jain make the case for both 6% and 10% margins by 2015.

General Motors’ North American EBIT the big driver

The Morgan Stanley team thinks the trajectory of EBIT in General Motors Company (NYSE:GM)’s North American segment is going to be the main driver of the automaker’s earnings and stock price. They see this as being true even if there were positive surprises in Asia and Europe to offset shortfalls in the North American division.

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General Motors Company (NYSE:GM) is aiming for a 10% North American EBIT margin by 2016 or not long after. Jonas and his team actually believe GM could achieve a 10% margin in North America as early as 2015, saying the year could by the automaker’s “best shot” to hit that goal. However, they’re projecting for EBIT margins in the region to peak at 8% and then fall to 5% for the long term. This creates the basis for their earnings per share estimate of $4 in 2015. That estimate is 16% lower than consensus.

The bull case: how GM could end up with 10% margins

If General Motors Company (NYSE:GM) does achieve 10% EBIT margins in the North American segment in 2015, then the Morgan Stanley team thinks this will be due to mix and tailwinds from market share. Specifically, they say Ford Motor Company (NYSE:F) could create benefits for GM through problems with the launches of its new trucks.

The analysts say with an increase of 4% in North American volume, plus $1 billion extra due to mix, neutral pricing, a headwind of $300 million and no expenditures for recalls (which seems near impossibly now) could possibly create a 10% margin in the region. However, even in this case, they think the company would need a variable EBIT margin of almost 60%, which is about four times the cumulative variable EBIT margin in the region between 2010 and 2013.

They also note that General Motors Company (NYSE:GM) is going to start negotiations with the United Auto Workers union very soon. Negotiations begin late in the second quarter of 2015 and are expected to last through early in the fourth quarter of 2015. The Morgan Stanley team notes that this is a delicate situation as GM needs record-high margins while also maintaining the savings management won through a big fight with the largest union it deals with.

The bear case: how General Motors could see 6% margins

At the opposite end of the spectrum, the analysts also see a 6% margin as being possible. They say product costs and pricing offer the biggest downside risks to margins in the company’s North American margins. To come up with this percentage, they assume a 2.5% growth in volumes, a -2% headwind due to pricing, and $1.3 billion in cost headwinds, which includes increasing variable costs.

They say a 6% margin for North America in 2015 would disappoint Wall Street because it implies earnings of $3.25 per share. However, Jonas and his team say even 6% would be a “respectable” margin “by both historic and relative terms.” They say both General Motors Company (NYSE:GM) and its peers are currently at a “highly sensitive time in terms of increased capital and technical requirements.” The automaker is trying to satisfy demand in the U.S., which is currently peaking, while improving fuel economy. In addition, expenses to make sure the company offers quality adds creates “an extra, undefined burden” for the automaker.

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