View From Japan: GM Fate Tied to Emerging Markets

A penetrating look at the new General Motors Co. from a Japanese catbird seat is both timely and intriguing.

“Seeking Independence,” a new 48-page report from CLSA Asia-Pacific Markets’ Christopher Richter in Tokyo, examines prospects for the stripped-down U.S. auto maker.

“We find a lot to like in the new GM,” he says. “A leaner balance sheet, exposure to emerging markets and profitability that is competitive with global rivals.”

However, Richter questions whether the U.S. government ultimately will receive a positive return on its investment. His report was written before GM’s recent initial public offering, which it expected to bring about $20.1 billion.

The IPO took down the government’s stake by nearly half. Among the highlights of the report, Richter writes GM’s fate and fortunes lie in Asia and emerging markets, where vehicle sales exceed those in North America, a “disparity that is only likely to grow.”

GM is the top foreign auto maker in China, with a market share of 13% held by its two joint ventures and sales that recently surpassed those in the U.S., the report points out.

The auto maker says its October sales in China rose 19.6% to 199,641 units, making it the first global car company to sell 2 million vehicles in the country in a single year.

GM has leading market-share positions in other major emerging markets, as well, such as Brazil and Russia. It also recently formed a JV in India, where it has been lagging, with Chinese partner Shanghai Automotive Industry Corp.

GM says first global car company to sell 2 million vehicles in China in single year.

The U.S auto maker’s second-biggest subsidiary in Asia is GM Daewoo Auto & Technology Co., which holds 8% of the South Korean market and produces vehicles for a number of GM brands sold in other countries.

GM’s second-largest emerging-market presence is in Brazil, which accounts for 8% of the auto maker’s global volume. Richter says it “is likely to be an important contributor to GM’s growth in the years ahead.”

In Russia, where the vehicle market has been rebounding this year, GM sales have lagged behind the recovery. However, Chevrolet is the No.2 brand, while Opel and Cadillac enjoy an 8% market share.

“GM now achieves an operating margin in excess of 5%, which is better than its embattled rival Toyota (Motor Corp.), but is still at a disadvantage with substantial post-retirement liabilities,” Richter points out.

Looking ahead, Richter is forecasting a net profit for GM of $4.4 billion in 2010 and $7.7 billion in 20l4, by which time China-driven equity income should have more than doubled to $2.7 billion.

The auto maker’s recent revenue per unit in North America follows a trend observed for Toyota, Honda Motor Co. Ltd. and Nissan Motor Co. Ltd. As the 2009 financial crisis took hold, GM’s pricing dropped to extremely low levels, but since then has recovered remarkably.

The CLSA report notes an alignment of interests between the Detroit Three, which are trying to restore themselves as profitable enterprises, and the Japanese auto makers, which are being ravaged by the strong yen.

This leaves a situation where OEMs holding about 85% of the U.S. market are vastly more interested in keeping prices as high as possible, rather than compete for market share.

After assessing GM’s outlook, CLSA considers the risk for Toyota, Honda and Nissan, long the benchmark for setting standards of best practices in the global auto industry: “In a stunning reversal of fortunes, GM’s ROIC (return on invested capital) could exceed that of the strong-yen-weary Japanese Big Three from 2011-2014.”

Richter notes if the focus is just on the vehicle-manufacturing business and excludes a captive finance arm, a business GM only recently re-entered, Toyota and Honda operating margins were below GM in the year’s second quarter.

But he emphasizes Japan’s Big Three have a secret weapon: their strong balance sheets. All are industrial net-cash positive, whereas GM has 70% net debt, largely due to massive pension liabilities.

On the upside, at least near-term, the CLSA report foresees an edge for GM in the cost of capital, emphasizing that in 2011-2012, high foreign-exchange rates will make it difficult for Japanese auto makers to beat their cost of capital, and there will be enormous pressure on them to reduce their foreign-exchange exposure.

Only in 2013-14 does CLSA see the Japanese Big Three clearing their cost-of-capital hurdle.

Because the yen/dollar rate basically has no impact on GM, Richter sees the auto maker earning a clear premium to its capital costs from 2011 onward.