Why Market Is Putting Its Money on GM
U.S. and world markets held steady through threats of ground war or uncertain peace last week and applauded President Bush’s firmness with a midday rally Friday, giving a signal once again that a new, confident spirit is emerging for the U.S. economy in the postwar period.
As they have since shooting began Jan. 16, stock and bond markets demonstrated confidence that U.S. leadership could handle the situation in the Gulf--whatever happens. And in their overall strength--particularly in the support given the bellwether stock of General Motors--the markets said the postwar U.S. economy would pull out of recession and return to health.
That was no easy judgment to make, with housing and automobiles--two of the economy’s mainstays--in severe difficulty. Home building is at its lowest point in 10 years, and real estate agents believe that residential markets nationwide won’t revive for another two years.
Automobiles are in an extraordinary downturn. Cars weren’t selling before Iraq’s grab of Kuwait last Aug. 2, and people have stayed away from showrooms since. Ford and Chrysler are suffering losses and cutting production.
But the most extreme case is General Motors, the world’s largest car maker. It lost $1.6 billion in 1990’s fourth quarter--after a loss of $2 billion in the third quarter because of writeoffs on plant closings. The company is cutting production to its lowest point since the 1982 recession, but continuing losses will be severe--perhaps $1.8 billion in the first three months of 1991, analysts say. GM has cut its dividend from an annual rate of $3 a share to $1.60.
And yet GM stock, one of the market’s most widely held securities, has held steady through it all at about $36 a share--25% below its all-time high but considerably above its all-time low of $14. GM is even attracting recommendations from analysts, including the authoritative Mary Ann Keller of Furman Selz Mager Dietz & Birney, who is impressed that GM now has competent management, determined and able to solve the great company’s problems.
The GM story is fascinating because the solutions are so extraordinary and expensive.
Traditionally, when cars weren’t selling, auto companies cut costs simply by laying off employees. It was a crude policy, mitigated somewhat by supplemental unemployment benefits to workers on layoff. But it wasn’t an effective policy because it avoided tough questions about how many employees the company really needed; it avoided fundamental reforms of the car-making process.
Now that policy is history. Thanks to a new contract with the United Auto Workers, GM guarantees work to almost 400,000 employees. If there’s no work, they still get 95% of full pay, including benefits.
This is not lifetime employment, a la Japan. It is better. Where most Japanese auto workers are employed by supplier firms at lower pay and benefits, GM has one scale for all. It is expensive. Analyst Scott Merlis of Morgan Stanley estimates that the labor agreement adds $560 million per quarter to GM’s costs, which are already the highest of any auto maker.
Ford and Chrysler have similar UAW contracts, but they’re in better shape because in the 1980s they cut payrolls and transformed their factories for efficiency. GM didn’t. Rather, it went for miracle cures--first a massive investment in robots, then high-tech acquisitions of Highes Aircraft and Electronic Data Systems. It wound up the decade with its costs $800 per car higher than Ford or Japanese auto makers.
So GM got serious. It made the labor agreement in simple recognition that it couldn’t achieve efficiencies in its factories or dramatic increases in productivity if employees feared loss of their jobs. Cooperation was needed, and GM paid up to buy it.
GM also recognized that to keep its factories humming and its lifetime employees working, it needed to make and sell more cars. So it is redoing all its cars during the next three years. “Its new cars, led by the Buicks, are impressive,” says analyst Michael Bowyer of Duff & Phelps.
Still, because the war has chilled car buyers, GM is not getting the sales it needs.
And yet the stock price has held because the market believes that competent management, led by GM’s new chairman, Robert C. Stempel, will persevere and succeed.
“The model is what happened in Europe,” says analyst Keller, author of “Rude Awakening,” a book about GM’s gradual realization that it had serious troubles. “They were in terrible shape in Europe in the late 1970s,” she says. But slowly GM reformed its European operations and recovered. “Now they’re in terrific shape--earning $2 billion a year in Europe,” Keller says. “But the reform process took seven years.”
GM’s North American operations could take three to five years to reform.
The stakes are high. If GM doesn’t succeed, it will be broken up and reduced in size to where it can make a consistent profit. But that would be a very serious loss for U.S. industry, which gains from supplying and working with GM--the world’s largest manufacturing company, with $125 billion in annual sales.
By the same token, with such massive sales volume, the opportunity is tremendous: A profit increase of one penny per dollar of sales would yield $1.25 billion, or $2 a share, in additional earnings.
The market, taking the long view, is betting on success. Just as it’s betting on competent leadership doing a better job with the U.S. economy when peace comes, which one way or the other is very soon. The trend, as it has been since Jan. 16, is confident.
