General Motors (GM) Raised to Investment Grade at S&P

(Updated - September 25, 2014 4:25 PM EDT)

Standard & Poor's Ratings Services today raised its corporate credit rating on U.S. automaker General Motors Co. (NYSE: GM) to 'BBB-' from 'BB+', and revised the outlook to stable from positive.

At the same time, we raised our issue-level rating on GM's unsecured debt to 'BBB-' from 'BB+' and simultaneously withdrew our '4' recovery rating on that debt, because we do not assign recovery ratings to the issues of investment-grade companies.

Following our upgrade, we expect the release of the collateral and guarantees under the revolving credit facility. Thus, we now classify the revolver as unsecured as it is no longer structurally advantaged to the outstanding rated unsecured notes. As a result, we lowered the rating on the revolver to 'BBB-' from 'BBB' to equate it with the corporate credit rating.

At the same time, we raised our corporate credit rating on GM's captive finance subsidiary General Motors Financial Co. Inc. (GM Financial) to 'BBB-' (at the same level as the rating on GM) from 'BB' and removed the ratings on GM Financial from CreditWatch positive after designating the entity as a "core" subsidiary of GM. We also raised our issue-level rating on GM Financial's unsecured debt to 'BBB-' from 'BB-'.

The upgrade reflects our improved assessment of GM's business risk profile based on better prospects for profit diversification across regions over the next two to three years. We believe GM will likely sustain its improving track record of profitability in North America (excluding recall-related headwinds), achieve its mid-decade profitability target in Europe, and maintain its strong market share in China. The upgrade also reflects our expectation that GM's credit measures should remain strong and appropriate for the current rating, given a generally favorable automotive market backdrop.

GM's high-profile recalls so far this year remain a negative factor in our assessment of GM's business, but we expect ongoing cash outflows associated with the recalls to be manageable in context of the company's strong liquidity. As total announced recalls approached 29 million vehicles, GM recorded recall-related charges of about $2.5 billion (over 90% in North America) during the first half of 2014. GM has also announced the creation of a compensation program related to faulty ignition switches and estimates a charge of up to $600 million. The total amount of the payout under a compensation program for accident victims and their families related to GM's ignition switch defect is not known at this point, and there is no aggregate cap on the compensation plan. We believe the company is likely to make most of the payouts by the middle of 2015. With nearly $39 billion in total automotive liquidity (i.e., not including liquidity at GM Financial), including about $28 billion in cash as of the end of the second quarter 2014, we believe GM has ample capacity to make these payments. In addition to GM's strong liquidity, our expectation for meaningful FOCF generation over the next two years should allow the company to manage several billion dollars of additional direct cash outflows while maintaining strong liquidity. We believe GM would be able to absorb any adverse developments related to the bankruptcy judge's pending decision on the treatment of lawsuits as prepetition or post-petition claims. The outcome of investigations currently underway by the U.S. Department of Justice (DOJ) and many state attorneys general will determine the ultimate magnitude of fines and cash settlement costs for GM. As a reference point, in March 2014, Toyota agreed to settle a government probe initiated in 2010 and made a $1.2 billion payment as part of the agreement. The probe related to millions of recalls on its popular vehicles in 2009-2010 for admittedly misleading consumers and the government over unintended acceleration.

In our view, GM will maintain its solid competitive position in North America which, along with its improved cost base, supports prospects for segment EBIT margins in North America in the high-single-digit percentage area (excluding recall-related costs). Despite the ignition switch and other recalls that materialized in 2014, we expect GM to maintain its top market share in the U.S. Overall light-vehicle market share for GM has been steady, signaling that the recent recalls hadn't significantly dented consumer appetite for the company's vehicles. Some segments such as passenger cars have faced declines in recent months, but GM's overall sales prospects remain good. In our opinion, the biggest risk factor--that market share would meaningfully decline because of reputational damage--has not transpired.

Our base case assumes GM continues to generate meaningful cash from its Chinese joint ventures (JVs). GM remains a leader in China, the world's largest light-vehicle market, with more than 14% of market share through various JVs in 2013. These JVs are profitable, with a roughly 10% net income margin and more than $1.7 billion of equity earnings in 2013. We assume good performance will continue in China. As a result of competitive pressure, GM has lost some market share in China in the first six months of 2014. However, we expect modest recovery following the launch of a new SUV--and this supports our expectation for meaningful dividends (approaching $2 billion) from its unconsolidated Chinese JVs in our base case for 2014 and 2015.

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