Shares in General Motors (GM, Financial), jumped to a four-month high yesterday after the company announced that it is going to restructure its operations.
The massive restructuring will see up to 14,000 workers laid off, and five plants across North America closed, as the company attempts to rebase its business model for the 21st century.
Mixed signals
The giant restructuring has sent mixed messages across the market. Some analysts believe that it is a sign of things to come, a reflection of the cooling U.S. economy, which will ultimately result in a recession. Others are seeing this change as a reflection of the way the auto industry is developing. Daimler and BMW have both already issued profit warnings this year, and China's Geely has decided to abandon the initial public offering of Volvo Cars. On top of this, General Motors' peer Ford (F, Financial) is also planning $14 billion of cost savings, which analysts believe will be directed at struggling South American and European operations.
On the other hand, the company's decision to aggressively shut factories and cut workers has been a long time coming. According to the U.S. Center for Automotive Research, unused capacity across the U.S. car industry amounts to 3.2 million vehicles annually; GM reportedly accounts for around a third of this total. For a company that is only 10 years out of a serious bankruptcy, running this much extra capacity when it is not needed seems excessive.
GM's decision to cut such a large percentage of its workforce reflects the way the world is moving towards more automation and technology in production processes. For example, the number of components required to manufacture the drivetrain for an electric vehicle is just a fraction of what would be necessary for a traditional hydrocarbon auto. Fewer parts means fewer workers. Improvements in robotics technologies also reduce the number of roles for humans.
The market's immediate reaction to these job cuts seems to echo the idea that GM needs to improve its operational efficiency. The stock jumped nearly 6% ended the day up 4.8%.
Cash returns
Greenlight Capital founder, David Einhorn (Trades, Portfolio), has been arguing that this company is undervalued for the past two years, and it seems that this restructuring could become the catalyst that sees the shares re-rate higher from the level they have been trapped at since the company returned to public markets in 2010.
Einhorn as always argued that the company is significantly under-appreciated by the market. Investors do not understand the earnings power of the business and its much-improved financial positio, that will allow it to weather any downturn better than it has done in the past. In several previous letters, Einhorn has also informed his investors that he believes the company has significant excess capacity to repurchase shares -- these cost-cutting efforts will only improve the company's financial position and cash flow available for share repurchases.
GM has already spent a significant amount of time and effort trying to convince investors to buy its stock. The company is buying back shares, and the shares currently support a dividend yield of 4% -- more than double the S&P 500 average. Its third-quarter adjusted earnings per share were 42% higher than the same period a year ago, and underlying earnings before interest and tax rose 25% to $3.2 billion. Put simply, the company is still growing despite all of the headwinds it faces.
Meanwhile, the stock is changing hands for around six times forward earnings. Cost-cutting efforts will only improve profit margins and increase overall earnings.
Conclusion
So overall, GM's announcement that it will be cutting around 15% of its workforce around the world has been met with a mixed reception, but it seems to be a sensible decision from a financial standpoint considering the excess capacity the company has. By reducing this unneeded capacity, the business should be able to improve margins, return more cash to investors and more importantly, invest more money back into the enterprise to remain relevant at a time when the whole auto industry is facing significant upheaval.
Considering the stock's current valuation, after this development, shares in GM look attractive.
Disclosure: The author owns no share mentioned.
