Why Is General Motors Making This Investment in Cadillac?

Detroit automakers are well-known for making phenomenal trucks and SUVs. But one area where both Ford Motor Company (NYSE: F) and General Motors (NYSE: GM) have historically lagged foreign competitors has been their luxury lineups. Furthermore, Detroit automakers have begun distancing themselves from producing sedans and passenger cars in the U.S. market. So what’s up with GM’s $175 million investment to build two next-generation Cadillac sedans? And why should investors care?

Weak U.S. results, but…

Cadillac’s U.S. sales fell 8% in 2017, leading people to ask if General Motors’ Cadillac experiment failed, and Ford hardly did better, as Lincoln snapped its three consecutive years of gains with a slight decline.

Data source: Ford’s sales press releases. Chart by author.

Worse for Lincoln — and Ford investors — is that the luxury brand’s sales in the U.S. aren’t bouncing back and are down 13.4% through May. However, Cadillac’s global story is far more promising than Lincoln’s. The former only recently started selling in China and isn’t in Europe, and is more intriguing than some GM investors may realize. In fact, despite the 8% decline in the U.S., Cadillac’s global sales jumped 15.5% during 2017, thanks in large part to the luxury brand’s staggering 50.8% growth in China. That growth was enough to overtake the U.S. as Cadillac’s highest-volume market in 2017.

With a booming overseas growth story, there’s incentive for GM and Cadillac to match that growth here in the States, and that’s what management aims to do as it begins to retool and equip the Lansing Grand River Assembly Plant for two new Cadillac sedans, which are rumored to be named the CT4 and CT5. Those two products are expected to mark the end of the ATS, CTS, and XTS sedans in Cadillac’s portfolio and are targeting the next-generation luxury buyer.

The 2019 XT4 was developed on an exclusive compact SUV architecture. Image source: General Motors.

“The XT4 is a cruise missile right into one of the hottest growing segments that is really populated by a young and very affluent and very discerning demographic. It is an area we have been eager to get into,” Cadillac President Johan de Nysschen said following the unveiling of the vehicle, according to Automotive News.

While investors will have to wait a year or so for the CT4 and CT5 rollout, the XT4 compact crossover will launch during the fourth quarter, and the refreshed portfolio is expected to significantly drive sales and profits. In fact, de Nysschen said he expects it to become the best-selling vehicle in its segment. That would put it in the ballpark of 50,000 units, which is a significant chunk considering Cadillac totaled only 156,440 units in the U.S. last year.

This is a big deal

For investors, this is more than just new nameplates and vehicle launches. These rollouts are expected to make a significant difference and double Cadillac’s profits through 2021 — with the biggest profit-driving force coming from the United States.

Image source: GM’s Deutsche Bank Global Auto Industry Conference presentation, Jan. 16, 2018.

Investors who keep abreast of sales data often overlook luxury sales because they’re dwarfed in volume by mainstream vehicles. That’s a mistake, because the historical rule of thumb is that luxury vehicles, while only generating roughly 10% of industry sales, generate almost a third of industry profits. Luxury brands are high-margin, high-revenue products, and will become increasingly important to automakers’ bottom-line growth story as the U.S. new-vehicle market slows.

General Motors has spent $464 million in manufacturing investments on Cadillac over the past two years alone, according to Automotive News. At first glance, that might seem puzzling with people flocking to SUVs and trucks and surging investments in driverless vehicles and electrified lineups, not to mention Cadillac’s 8% decline in the U.S. last year. But with an incredible growth story overseas, and oversize profits compared to sales volume, this is a move that makes far more sense for its bottom line than many realize.

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Daniel Miller owns shares of Ford and General Motors. The Motley Fool recommends Ford. The Motley Fool has a disclosure policy.

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