GM's Luxury Car Push Could Produce Long-Term Gains

Aug. 8.12 | About: General Motors (GM)

General Motors (NYSE:GM) is making aggressive moves to bolster its legendary luxury car brand Cadillac. If this strategy is successful, it will give GM new sources of revenue and increased profits.

The first of these moves was the unveiling of the first compact Cadillac model in 25 years, the ATS, which is designed to challenge the dominant luxury Sedans on the market, the BMW 3 series, and the Mercedes Benz (OTCPK:DDAIF) C-class. The automaker wants to sell 50,000 units of the ATS a year, which is supposed to translate into a very nice infusion of cash into the company's coffers.

The price range for the ATS is between $33,095 and $49,000, which is designed to make it competitive with the 3 Series and C Class. Industry analysts at IHS Automotive estimate that GM might sell around 60,000 ATS cars next year. Unfortunately, the amount of revenue generated from such sales is hard to determine because of the deals Cadillac may have to give customers to get them to buy an unproven new model like the ATS.

The ATS may also increase Cadillac's share of the luxury market by appealing to buyers who like to lease. Around 60% of Mercedes and BMW's sales in the U.S. are leases. Only about 36% of Cadillac's sales are leases, which indicates it is not appealing to the majority of luxury car buyers.

Luxury Carmakers Have Higher Stock Values

The biggest impact this could have on investors is to increase long-term revenues. Luxury cars have a higher mark up so increased luxury vehicle sales lead to a high cash flow. Luxury vehicles can also generate extremely high profits as the case of Audi proves. In addition to its own brand of cars, Audi also owns Lamborghini, and it is the leader in the premium and supercar segment.

Unfortunately for GM, non-German companies seem to have a hard time competing in that market. Tata Motors Limited (NYSE:TTM), which owns the well-respected British brands Jaguar and Land Rover, has not seen the kind of success that the Germans have enjoyed.

Driver Bias Could Be Roadblock to GM Plans

There is a strong possibility that driver bias in the US and Canada might keep GM from increasing its luxury car market share. Even if the ATS is technologically advanced, GM might have a hard time selling enough of them to boost revenues.

It's hard to see Cadillac convincing North Americans under 50 that its luxury sedan is as good as anything that BMW and Mercedes sell, let alone take sales away from higher-end competitors like Tata's Jaguar and Audi. Car reviewers interviewed by Bloomberg said that the ATS's performance is comparable to the Germans, but GM is going to have a difficult time convincing actual car buyers of that. I believe that it will take a while for the ATS to really gain momentum.

The average age for Cadillac drivers in the United States is around 58. The average age for BMW drivers is around 49, which shows you the problem that Cadillac is facing. It just can't get Americans under a certain age to buy its products. The only Cadillac vehicle that has had a strong appeal to younger drivers is the Escalade SUV, which unfortunately, has a reputation as a ride for gangsters and rap singers. Obviously, that image doesn't appeal to the kind of executive who buys a luxury sedan.

The only real edge the ATS seems to have is price. Its base price is $33,095, compared to $36,500 for the 3 Series and $34,800 for the C-Class. The lower price may win over some buyers, but the savings may not be enough to sway most luxury buyers.

The only way lower prices can help Cadillac move the ATS is if it can translate prices into lower lease payments because most luxury cars are leased. Currently, Mercedes and BMW lease sedans for around $400 a month. If Cadillac could lease the ATS for under $350 a month, it will be competitive in the North American market, yet the home market might not matter that much.

Real Success Could Be in China

Cadillac may have better luck with the ATS in China, where drivers are not as familiar with the company's reputation. It will be a lot easier for Cadillac to convince first generation Chinese luxury car buyers to lease an ATS than to change the buying habits of Americans.

GM has launched a worldwide marketing push for the ATS, which involves commercials shot at locations such as China's Guoliang Tunnel Road and the legendary Monaco Grand Prix Course. Joel Ewanick, GM's global marketing chief, told reporters that the ATS is designed to help build Cadillac as a global brand.

Bringing out the ATS is a smart move for Cadillac because the sedan is an entry level luxury car. There are vast numbers of entry level luxury car buyers in China, many of whom are already buying GM products. GM sold 1.42 million vehicles in China in the first half of 2012.

The ATS is not the only new Cadillac that GM is planning to push in China. The company is also planning to introduce a new flagship sedan designed to appeal to the Chinese market. The name for the new sedan hasn't been announced yet, but the car is supposed to be based upon the Cadillac Ciel concept car. The new flagship will not be in showrooms for at least two years.

The new flagship Sedan is supposed to offer a level of luxury similar to brands such as Bentley and Tata's Jaguar. The obvious market for that car is the emerging entrepreneur class.

GM's management has apparently decided to give Cadillac the resources it needs to develop several other models. No details on those proposed models are available, but one of them is supposed to be a new crossover that will be smaller than its SRX.

The problem with long-term projects such as the effort to take Cadillac global is that they may not generate revenue for years, so they will have no immediate effect on share value. Unfortunately these efforts could eat up revenue because they will require a lot of money. GM is reportedly spending $297 million just to advertise the ATS. That may translate into significantly lower earnings per share for the next few years.

The real exciting thing about the project to revitalize Cadillac is that it could give GM a large new revenue generator in China and other developing markets. If it can succeed in positioning Cadillac as a major luxury brand in China, GM will prove that its success in that country is no fluke.

There is a lot of money in the luxury car market, but there's also a lot of competition in it. In addition to Mercedes and BMW, GM has to contend with Audi, Tata Motors, Toyota's (NYSE:TM) Lexus, and Nissan's Infiniti just to name a few. Whether Cadillac can carve out a niche in a crowded luxury car field remains to be seen.

So Where is GM Going?

GM is in an excellent position to leverage existing resources such as Cadillac and its Chinese sales network into future profits.

Unfortunately, this kind of leverage is not automatically reflected in its stock value. Any increased revenue from the changes at Cadillac is a year away at the earliest. That means all the market sees in GM for now is the losses in Europe.

This makes GM a textbook example of a value stock because it is a company with a lot of potential that is going through a rough stretch. Unfortunately, it's still a risk because GM is going to have to spend a lot of money on assets like Cadillac before it sees a serious increase in stock value. With that said, I think GM will be successful in its luxury car push, and it will show in the stock value in the mid to long-term.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.