Extended Shutdowns Raise Uncertainty for GM's Dividend; We Plan to Sell Our Shares on Monday

In our last General Motors (GM) note on March 19, we wrote the following about the automaker's Borderline Safe Dividend Safety Score:

Shares of GM have surged more than 40% since then, but the outlook for auto producers has arguably continued to dim.

Production shutdowns have been extended, the employment backdrop has become weaker, and demand for big-ticket purchases seems increasingly likely to be deferred for a while after the pandemic subsides.

These factors have potential to extend GM's cash burn, removing the buffer it has in place for its dividend.

Based on our analysis below, we are downgrading GM's Dividend Safety Score to Unsafe.

We also plan to sell our GM shares in our Top 20 and Conservative Retirees portfolios on Monday, April 20. In the unlikely even that we buy a stock with the proceeds prior to our next newsletter on May 1, we will send out an email.

We initiated our position in GM in July 2015, buying a stake for $30.39 per share. During our holding period, we received $7.18 per share in dividends.

Based on GM's current price around $22, we will be closing out our investment with about a 3% total loss.

While far from disastrous, especially in our diversified portfolios, the S&P 500 trounced GM with a return in excess of 30% since July 2015.

We bought shares of GM because we thought the business had structurally improved its resiliency since the 2007-09 financial crisis and could continue increasing its profitability by further narrowing its operational focus.

Combined with GM's potential to develop material revenue streams in self-driving cars and electric vehicles, we felt the stock was attractively priced at the time.

On one hand, the company made a lot of progress in these areas.

GM's operating margin improved from 4.2% in 2014 to over 8% in 2019 (before incurring costs related to its labor strike), and its self-driving car division Cruise increased its headcount from 40 people in 2016 to more than 1,500 today, earning a valuation of $19 billion last year.

GM's financial health also remained sound, including a credit rating upgrade to BBB from Standard & Poor's in 2017.

However, the timeline to commercialize self-driving cars continues getting pushed out, and the COVID-19 pandemic has created unprecedented stress for GM's core auto manufacturing business.

When we published our March 19 note, GM had expected to suspend production and idle factories for about two weeks due to the virus outbreak. That seemed manageable.

But automakers continue pushing out that estimate. For example, Nissan on Thursday said it would further extend production downtime at all of its U.S. manufacturing facilities until mid-May.

Capital-intensive car manufacturers burn through a lot of cash when demand drops, much less comes to a screeching halt.

Ford said that as of April 9 it had $30 billion of cash on its balance sheet. Even after suspending the firm's dividend, management believes this cash hoard is only sufficient to get the company through at least the end of September with no incremental vehicle production or financing actions.

Thanks to its proactive restructuring and exit of weaker markets in recent years, GM has a stronger financial profile than Ford. However, it can't last forever if production lockdowns persist.

On March 24, GM said it borrowed $16 billion from its credit facilities, increasing its cash on hand to around $32 billion.

GM's 40-day strike in late 2019, which idled factories, reduced the company's 2019 free cash flow by about $5.4 billion.

If that rate of burn (nearly $1 billion per week) remained applicable today, GM's cash would last it around 34 weeks.

However, the company's cash will be further reduced by working capital drawdowns (GM previously estimated about a $5 billion hit during downturns as it collects less cash from dealers and pays suppliers).

GM's dividend also costs the company around $550 million per quarter.

Joe Spak, an analyst at RBC Capital Markets, believes GM's cash could last around 21 weeks without production.

Besides production uncertainties, there may not be much pent-up demand for big-ticket items like trucks and SUVs once we get to the other side of the crisis.

No one knows what the unemployment picture will look like, but consumer confidence could remain rattled for a while. Ford's portfolio of nearly $100 billion of auto loans could encounter unusual performance challenges as well.

GM has historically held two years' worth of dividends (about $4.4 billion) in cash to protect its payout during downturns, but this extraordinary situation could cause management to change their plans.

GM typically declares its second quarter dividend in late April. Unlike Ford, which suspended its dividend, GM did not change its payout when it provided a business update in March, suggesting it wanted to try maintaining its dividend.

On March 24, GM spokeswoman Julie Huston-Rough said management "will evaluate how the macro backdrop evolves before deciding" how to proceed with the dividend.

Given the current backdrop, which is far from a "normal" industry downturn, it's hard to imagine management having confidence to be anything but stingy with the company's cash.

Therefore, instead of waiting for more information, it could be argued that the prudent thing for GM to do would be to temporarily cut or suspend its dividend as early as this month.

In a best-case scenario, GM's dividend will remain frozen and the company will remain the best house in a bad neighborhood. Perhaps lockdowns will end in May, and auto demand will come roaring back.

A lot of bad news is already reflected in GM's stock price, so the stock's short-term performance could be quite strong in that scenario. 

Overall, given our weakening faith in GM's short-term financial health, dividend safety, and ability to generate profitable long-term growth through new revenue sources like self-driving cars, we would rather move on to other businesses that have more within their own control. 

GM next reports earnings on May 6, though its dividend declaration will likely come sooner. Current shareholders who decide to continue their ride with the company need to feel comfortable with the widening range of potential outcomes facing GM as a result of the pandemic.