GM - General Motors

[cmlber]

...

Interest cost is not based on the net liability, it's pension benefit obligations times the discount rate.  So, to the extent your returns on plan assets equal the discount rate, why would the funded status change?  Required contributions may change, but the balance sheet funded status would not.

 

Also, GM has recorded pension income, not cost, in recent years; exactly because of the point above, returns on plan assets have been higher than the discount rate.  This is one of the larger reasons why "earnings" have been so much higher than auto FCF.

I'm trying to see your perspective so let's see if we can turn this into a two-step argument: 1-what happens when realized return is less than expected return (with the return being above or below the discount rate) and 2-what this means for GM. 2- will be discussed if we can agree on 1 :)

 

The discount rate for obligations and the expected return on invested assets are remotely related conceptually but they are two different things and I submit that you are overlooking what is bypassing the income statement.

 

Using the real-life example described above, If I were to buy your education fund obligations, I would use a discount rate in correlation with your overall counterparty risk as a sponsor, not in correlation to your asset allocation related to your investments managed in separate accounts. This is why discount rates for the liability side usually correspond to highly rated bonds. It would be possible to try to match the liability and the asset side with a similar risk profile but it would be difficult and that's not the way pensions are typically funded.

 

As mentioned above, whatever discount rates used for the pension obligation, the difference between realized returns and expected returns, up to a 10% value of assets or liabilities corridor, bypasses the income statement and the net liability (or net asset) number but ends up in equity through OCI. This makes sense because a certain degree of smoothing is reasonable and if, over time, the expected vs realized mismatch balance then the end result is neutral. However, if the company, on a net basis, keeps on building actuarial losses because of realized returns that are lower than expected returns (discount rate for liabilities does not matter here), eventually very true negative cashflows will need to occur to balance the books. This is very insidious because companies can 'manage' this aspect for a very long time and 10% of the greater of the defined benefit obligation or the fair value of the plan assets is a very large number.

 

If interested, I suggest to look at GE's pension management, accounting and reporting.

 

Where am I wrong?

 

I agree if you're valuing GM off EPS, then the expected return matters because as you said it impacts "earnings."  Looking strictly at EPS, in part 1 of your question, you and I agree that at some point EPS will be lower in the future to account for "over-earning" in the past with an unrealistic expected return on plan assets. 

 

But I don't value GM on EPS but instead value it off FCF.  I also account for the net pension liability as something close to, but not quite as "bad" as, debt in adjusting my EV.  It's like low quality float, it has a reasonably low cost (the discount rate) but never really matures so long as the business continues to operate and you're well funded to the point of not requiring mandatory contributions.  If you start the year 92% funded with an expected return of 7% and only earn the discount rate (plus service cost / benefit obligations to be exact, but that's negligible in this case), you'll still end the year 92% funded.  So to the extent a 92% funded plan doesn't require mandatory contributions, it has no cash flow implications to earn less than the expected return so long as you're earning above the discount rate.

 

My main point to begin with though was that the expected return on plan assets isn't used to calculate the net liability on the balance sheet.

[Spekulatius]

I also account for the net pension liability as something close to, but not quite as "bad" as, debt in adjusting my EV.

 

In my opinion, pension liabilities are way worse than debt. Essentially it is debt with a high coupon (the expected rate of return 7-8%) and a maturity of 30 years or so. Debt is easy and cheap now, pension are not. Pension liabilities actually get worse as interest rate go lower.

[cmlber]

I also account for the net pension liability as something close to, but not quite as "bad" as, debt in adjusting my EV.

 

In my opinion, pension liabilities are way worse than debt. Essentially it is debt with a high coupon (the expected rate of return 7-8%) and a maturity of 30 years or so. Debt is easy and cheap now, pension are not. Pension liabilities actually get worse as interest rate go lower.

 

The coupon on it is not 7-8%, it’s 4%, which is lower than GMs longer term bonds yield.  And just as the liability gets worse as rates go lower, it gets better as rates go up.  In the long run that aspect of it is a wash imo.  It’s also somewhat naturally hedged since rates going down means new cars are easier to finance.

[Cigarbutt]

...

I agree if you're valuing GM off EPS, then the expected return matters because as you said it impacts "earnings."  Looking strictly at EPS, in part 1 of your question, you and I agree that at some point EPS will be lower in the future to account for "over-earning" in the past with an unrealistic expected return on plan assets. 

 

But I don't value GM on EPS but instead value it off FCF.  I also account for the net pension liability as something close to, but not quite as "bad" as, debt in adjusting my EV.  It's like low quality float, it has a reasonably low cost (the discount rate) but never really matures so long as the business continues to operate and you're well funded to the point of not requiring mandatory contributions.  If you start the year 92% funded with an expected return of 7% and only earn the discount rate (plus service cost / benefit obligations to be exact, but that's negligible in this case), you'll still end the year 92% funded.  So to the extent a 92% funded plan doesn't require mandatory contributions, it has no cash flow implications to earn less than the expected return so long as you're earning above the discount rate.

 

My main point to begin with though was that the expected return on plan assets isn't used to calculate the net liability on the balance sheet.

First, I referred above to the interest cost on net liability which is IFRS. My mistake.

 

I see better what you're getting at. In the end, expected returns are defined above the discount rates in order to meet obligations when they come due so there are also cash flow implications but I understand your point about earning around the discount rate without lowering the recorded funded status, especially with the difference between the two rates having become narrower lately.

 

Your view of the pension plan as cheap debt needs to be reconciled with the fact that extra-contributions are typically required in times of the cycle where operating cash flows get lower. And GM's pension plans remain significantly under-funded at this point of the cycle and as Mr. Buffett noted about large US companies in his letter to Kay Graham about pensions in 1975, the pension fund assets' absolute value (largely off-balance sheet) can reach levels comparable to the market value of whole companies (today's market cap: 53.4B and market value of plan assets end 2018: 69.6B). I was following GM in the early 2000's and they made unusually high contributions then and this was accompanied by significant credit downgrades.

 

Even if you don't value GM using EPS, many market participants do and I find it intriguing that GM plays this game also. Mr. Buffett had voiced general concerns in his 2007 annual letter. Since then we've had the financial crisis which was very detrimental, among others, to defined-benefits pension plans many of which became very significantly under-funded. Interestingly, accounting rules were introduced to make it easier for companies to deal (defer correction) with pension deficits. Unfortunately, we have a new normal where underfunding is the norm.

https://davidgcrane.org/?page_id=702

"the chickens won’t come home to roost until long after they retire."

[Cigarbutt]

...

But I don't value GM on EPS but instead value it off FCF.  I also account for the net pension liability as something close to, but not quite as "bad" as, debt in adjusting my EV.  It's like low quality float, it has a reasonably low cost (the discount rate) but never really matures so long as the business continues to operate and you're well funded to the point of not requiring mandatory contributions.  If you start the year 92% funded with an expected return of 7% and only earn the discount rate (plus service cost / benefit obligations to be exact, but that's negligible in this case), you'll still end the year 92% funded.  So to the extent a 92% funded plan doesn't require mandatory contributions, it has no cash flow implications to earn less than the expected return so long as you're earning above the discount rate.

My main point to begin with though was that the expected return on plan assets isn't used to calculate the net liability on the balance sheet.

This follow-up is related to potential cashflow implications that can occur when pension plans remain under-funded. The pension issue for GM has come down significantly but the deficit is still high when compared to other cash flows. Something that does not show up clearly in annual disclosures is that the slope of the curve describing potential cash contributions to the plans versus funding level changes significantly when the funding is around 85 to 90% and below.

Some numbers:

                                              2014      2015      2016      2017      2018

Annual cash contributions (B)      0.9        1.2        3.1        1.2        1.7

% level funding                          77        78        83          85        86

 

With an overall 86% funding level at end of 2018, one could evaluate the potential cash flows necessary to get funding to 100% in the next few years (conservative view). But like GM has been promoting, one could discount this over a very long time, could continue to  expect minimum contributions and could hope that expected returns will eventually close the gap but the present situation exposes to the risk related to the changing slope referred to above if realized returns do not match expectations. Historical review of GM's checkered past is useful here.

 

If anybody is interested, the changing relationship between funding levels and potential cashflow implications is also found in nature with the hemoglobin curve. Hemoglobin carries most of the oxygen in the blood. Healthy people typically have saturation levels close to 100%. Nature has made it that the oxygen pressure does not change much down to 90% saturation. This may create a false sense of security because once hemoglobin saturation goes below 90% the drop in oxygen pressure drops significantly. Post-mortem analysis spends some time about the period when saturation stood at around 90%. But typically, the key fundamental question is to answer why the 90% saturation level was not dealt with when it could.

[SharperDingaan]

Look closer at the PVBO.

A high proportion of retirees are close to end-of-life, implying higher run-off of the BO. New additions may have higher pensions, & live longer - but it is cumulatively not enough to fully offset that higher run-off. Shrinking BO, shrinking PVBO

 

For the most part the BO is not fully inflation indexed.

Therefore the discount rate should be the long-term discount rate + inflation. And if they can partially immunize the PVBO with something earning more than that, the discount rate rises even further. Additional PVBO shrink.

 

Look at the asset quality.

If the long-lived asset has a federal guarantee, it's appropriate. But if that long-lived asset also has equity participation (convertible debenture), at some point the asset value will exceed the expected - and produce pension income. It is a simple matter to repackage federal bailouts, as guaranteed conv debs, and resell them to DB pension plans.  PVBO shrink through pension income.

 

Not as negative as many might like to think.

 

SD

 

[JRM]

My understanding is after the bailout part of the negotiations with the union resulted in new hires receiving a defined benefit retirement option instead of a traditional pension. 

[Cigarbutt]

^For about the last twenty years, GM has been transitioning away from defined benefit plans and has moved towards formulas such as defined contribution plans so the pension plans will become essentially run-off entities. However, even if the program is 'mature', just like in insurance run-off books of business, these plans are very long-tailed and the liabilities are still huge. Something like 50% or more of eligible workers have reached the vesting period or are retired but, actuarially speaking, these people expect the contracted obligation to be honored for a very long time. This potential problem is not going away anytime soon.

 

The trend of moving away from defined plans started before the 2007-9 financial crisis but the episode accelerated the changes. Some suggest (a view I agree with) that the public bail-out influenced the priority of previous pension participants over new hires. The risk of 'adverse development' on the pension liability is limited versus pension participants due to the run-off nature of the plans.

 

However, there is still the discount risk (in addition to the expected return risk described before) that needs to be looked at. In the last 3 years, looking at GM and comparing to various surveys, it appears that GM is using a relatively high number. Since Jan 2019, the Baa yield in the US has gone down by 125 basis points. Such a move, even if very large, does not mean that the discount rate used at the end of this year will come down a lot due, in large part, to the leeway that keeps getting renewed and that allows companies to look back for a specified 25-year period (period when rates were higher) in order to come up with a "smoothed" number but the liability number is so large that even a small change in the discount rate could have a huge impact on the funded status. Also, looking back to 1982 (37 years ago!) and smoothing out the noise, this is pretty much a straight line down and we just had an official tweet suggesting that negative rates should be considered, if not promoted.

 

It looks like GM meets an unexpected and perfect storm (lower interest rates, lower markets, more difficult core business conditions) every few years and, retrospectively speaking, the pension issue has exacerbated other problems and I would bet that this will continue to be an occasional nagging issue even if of smaller relative magnitude.

[JRM]

Thanks for the info Cigarbutt.  I meant to say they moved new employees from a defined benefit plan to a cash balance plan. 

[Gregmal]

So sales are dropping, the corrupt union is costing the company billions, and the share price is a hair from the IPO price again. Outside of Radman who's loving his value investor street cred here, is there any argument Barra is the right person for the job anymore? She's not delivering on anything and one we're one poor earnings away from $30 and being in Ford territory. Additionally, I saw a note the other week I believe for Adam Jonas about the Waymo valuation being substantially scaled back. Not that Cruise was ever that lofty, but if the bubble for those types of companies is deflating, the window to IPO Cruise is closing...fun times being a GM bagholder.

[JRM]

Of course it had to be Softbank that invested in Cruise with an implied valuation of $19B.  The investments in Maven and Lyft appear to be poor allocation decisions.  The UAW union strike is ridiculous.  They were the only ones left standing after the bankruptcy and bailout and now they are on strike 10 years later. 

[RadMan24]

Of course it had to be Softbank that invested in Cruise with an implied valuation of $19B.  The investments in Maven and Lyft appear to be poor allocation decisions.  The UAW union strike is ridiculous.  They were the only ones left standing after the bankruptcy and bailout and now they are on strike 10 years later.

 

Media doesn't care about that. Shareholders were wiped out. GM still pays way above peers, but the temp work is contentious. I'm not sure how they tackle that issue.

[WayWardCloud]

GM to wind down its operations in Australia/New-Zealand and to sell its Thailand ones to Chinese automaker Great Wall.

https://media.gm.com/media/us/en/gm/news.detail.html/content/Pages/news/us/en/2020/feb/0216-international-markets.html

 

The move is consistent with their strategy of focusing on their profitable markets.

I'm confused why they're not disclosing the sale price. They only mention 1.1B in costs to shut it all down.

[Dalal.Holdings]

GM to wind down its operations in Australia/New-Zealand and to sell its Thailand ones to Chinese automaker Great Wall.

https://media.gm.com/media/us/en/gm/news.detail.html/content/Pages/news/us/en/2020/feb/0216-international-markets.html

 

The move is consistent with their strategy of focusing on their profitable markets.

I'm confused why they're not disclosing the sale price. They only mention 1.1B in costs to shut it all down.

 

Probably because, as usual, they sold this division for a loss or even—had to pay someone else to take it off their hands.

 

What a sorry state the traditional auto industry is in...

[Liberty]

What a sorry state the traditional auto industry is in...

 

GM is trading where it was in 2010 (ok, paid a lot of dividends, but still)... Meanwhile, imagine what someone with vision and talent could do with their engineering base and distribution footprint and free cash flow...

[Gregmal]

What a sorry state the traditional auto industry is in...

 

GM is trading where it was in 2010 (ok, paid a lot of dividends, but still)... Meanwhile, imagine what someone with vision and talent could do with their engineering base and distribution footprint and free cash flow...

 

Well, that was the dream. However, after a while (probably too long) it became clear this was just a fantasy.

[JRM]

It's an interesting battle to watch play out between the executive team and the union: who can strip more money from the company at the expense of shareholders.  i don't wish badly for American companies, but I don't see myself buying a Ford, GM, or Chrysler/Dodge product anytime soon.

[Gregmal]

It's an interesting battle to watch play out between the executive team and the union: who can strip more money from the company at the expense of shareholders.  i don't wish badly for American companies, but I don't see myself buying a Ford, GM, or Chrysler/Dodge product anytime soon.

 

Thats a big part of it. Too many hands in the cookie jar. I think you mentioned as well, on another thread, the fact that this gets too convoluted by all that nonsense as well as government prompted red tape. A takeout will never occur because of these things, and as we are seeing the last few years, even shutting down bad businesses takes WAYYY too long and gets dragged out much more than it should because there's extraordinary business conflicts at play with all the above.

 

While I do believe GM is a better business than Ford or FCAU, we're starting to see deceleration with those and even in some instances, IE Ford, the wheels falling off. So even if GM is better, its bound to get dragged down by the inevitable negative sentiment and sector wide carnage.

 

There is also a good likelihood, IMO, that GM/management is really just the hot shot mortgage broker type guys from The Big Short. Smart enough to stay out of their own way and make tons of money during the easy years, but at the end of the day, still, just dumb asses that will still get crushed when the cycle turns.

[Dalal.Holdings]

What a sorry state the traditional auto industry is in...

 

GM is trading where it was in 2010 (ok, paid a lot of dividends, but still)... Meanwhile, imagine what someone with vision and talent could do with their engineering base and distribution footprint and free cash flow...

 

That cash was never free tho...GM has a lot of mouths to feed, even after Ch 11. Also, FCF consistently < Net Income (compare with TSLA).

 

Better hope that cruise automation thing works out. These co's always talk about how they're making the pivot to tech by opening an office up in SF (see your boy Hackett at F), but for some reason they can't walk the talk. Almost like tech isn't in their DNA. Just wait for the next version of Cadillac CUE, it'll be usable we promise...Lol. Almost like they operate in a relatively commoditized business and can't escape it. I was fooled once too and used to own this thing...

 

It's ok, there's another, newer American automaker that breathes tech. Won't be long before you'll find out the true significance of the lack of tech chops at the old school automakers...

[mcliu]

GM = BlackBerry?

Tesla = Apple?

Model 3 = iPhone?

[DTEJD1997]

GM = BlackBerry?

Tesla = Apple?

Model 3 = iPhone?

 

You are forgetting one big thing.  Apple was/is consistently profitable.  All iterations of the iPhone have been profitable, some wildly so.

 

TSLA still has not achieved consistent profits...so I don't think the comparison is valid.

[Dalal.Holdings]

GM = BlackBerry?

Tesla = Apple?

Model 3 = iPhone?

 

You are forgetting one big thing.  Apple was/is consistently profitable.  All iterations of the iPhone have been profitable, some wildly so.

 

TSLA still has not achieved consistent profits...so I don't think the comparison is valid.

 

It’s very easy to be profitable with a product right out of the gate when you outsource all the manufacturing to Foxconn. Much harder when you run a giant factory in the SF bay area (just ask GM and Toyota who threw in the towel at NUMMI when cost of living in Bay Area was much lower).

[petec]

GM = BlackBerry?

Tesla = Apple?

Model 3 = iPhone?

 

You are forgetting one big thing.  Apple was/is consistently profitable.  All iterations of the iPhone have been profitable, some wildly so.

 

TSLA still has not achieved consistent profits...so I don't think the comparison is valid.

 

It’s very easy to be profitable with a product when you outsource all the manufacturing to Foxconn. Much harder when you run a giant factory in the SF bay area (just ask GM and Toyota who threw in the towel at NUMMI when cost of living in Bay Area was much lower).

 

I have the greatest respect for what Tesla has achieved and I suspect they are just beginning, but the reason they are making lower profits than Apple is because they are competing in a much more commoditised market. That is not to say their product isn't differentiated - it clearly is in some ways - but in terms of getting you from A to B it does much the same as any other car, just with a bit more acceleration and an added feel-good factor (for some). The same can't be said of the iPhone, which was hugely differentiated when it came out and is now protected by app and data moats which confer silly margins.

[Dalal.Holdings]

GM = BlackBerry?

Tesla = Apple?

Model 3 = iPhone?

 

You are forgetting one big thing.  Apple was/is consistently profitable.  All iterations of the iPhone have been profitable, some wildly so.

 

TSLA still has not achieved consistent profits...so I don't think the comparison is valid.

 

It’s very easy to be profitable with a product when you outsource all the manufacturing to Foxconn. Much harder when you run a giant factory in the SF bay area (just ask GM and Toyota who threw in the towel at NUMMI when cost of living in Bay Area was much lower).

 

I have the greatest respect for what Tesla has achieved and I suspect they are just beginning, but the reason they are making lower profits than Apple is because they are competing in a much more commoditised market. That is not to say their product isn't differentiated - it clearly is in some ways - but in terms of getting you from A to B it does much the same as any other car, just with a bit more acceleration and an added feel-good factor (for some). The same can't be said of the iPhone, which was hugely differentiated when it came out and is now protected by app and data moats which confer silly margins.

 

If you think they are *undifferentiated*, how do u explain the large market share in EVs, the failure of the Bolt/Volt/iPace/Etron/i8? No moat and no brand equity must explain how easy Tesla has been to disrupt, at least that’s what CoBFers claim. Are Tesla’s also *undifferentiated* from a $150K taycan with 200mi range? Sorry, I am in the weeds here and I know when it comes to Tesla, we like discussing higher level, more important things like Elon’s tweets.

 

And clearly Tesla also doesn’t have a software platform much better than any competitor where they can charge customers for services and earn fat margins like AAPL did...

[RadMan24]

GM = BlackBerry?

Tesla = Apple?

Model 3 = iPhone?

 

You are forgetting one big thing.  Apple was/is consistently profitable.  All iterations of the iPhone have been profitable, some wildly so.

 

TSLA still has not achieved consistent profits...so I don't think the comparison is valid.

 

It’s very easy to be profitable with a product when you outsource all the manufacturing to Foxconn. Much harder when you run a giant factory in the SF bay area (just ask GM and Toyota who threw in the towel at NUMMI when cost of living in Bay Area was much lower).

 

I have the greatest respect for what Tesla has achieved and I suspect they are just beginning, but the reason they are making lower profits than Apple is because they are competing in a much more commoditised market. That is not to say their product isn't differentiated - it clearly is in some ways - but in terms of getting you from A to B it does much the same as any other car, just with a bit more acceleration and an added feel-good factor (for some). The same can't be said of the iPhone, which was hugely differentiated when it came out and is now protected by app and data moats which confer silly margins.

 

If you think they are *undifferentiated*, how do u explain the large market share in EVs, the failure of the Bolt/Volt/iPace/Etron/i8? No moat and no brand equity must explain how easy Tesla has been to disrupt, at least that’s what CoBFers claim. Are Tesla’s also *undifferentiated* from a $150K taycan with 200mi range? Sorry, I am in the weeds here and I know when it comes to Tesla, we like discussing higher level, more important things like Elon’s tweets.

 

And clearly Tesla also doesn’t have a software platform much better than any competitor where they can charge customers for services and earn fat margins like AAPL did...

 

Clearly, you're trolling about TSLA in a GM thread.