Does GM’s new capital plan make sense?

March 9, 2015, 6:19 PM UTC

When GM announced its new, “comprehensive capital allocation framework” on Monday morning, most analysts and pundits focused on the $5 billion stock repurchase plan for 2015 and 2016. The buyback plan forestalled a proxy fight from activist investor Harry Wilson. By mid-day, GM’s (GM) stock price had jumped almost 3% on the news.

But the most compelling element of GM’s announcement is not the stock buyback, it’s the automaker’s pledge to generate 20% returns on the future dollars invested in launching new models, updating existing ones, and all other capital expenditures.

GM is really sending two messages that might appear contradictory.

First, it pledges to return far more cash to shareholders buybacks, plus a 20%, or $970 million, increase in the dividend. In general, buybacks signal that management has no better use for their capital than to return it to shareholders. The obvious question arises: if this business is so great, why can’t the company find fresh opportunities that promise high returns?

Second, GM is unveiling plans to plow more — not less — money into the business of making and selling cars. Last year’s capex was $7.1 billion. In the press release, GM repeated its pledge to invest $9.1 billion in plants and products this year, “including a more aggressive vehicle launch cadence in the coming years.” It then states the goal of a 20% return on invested capital, or ROIC.

In other words, a company that’s sending more capital back to shareholders is also touting the high profitability of reinvesting in its core business. That apparently hasn’t been the case in the past few years. From 2012 to 2014, GM lavished $22.7 billion on capex, but failed to raise cash from operations, which fell over the three-year period from $10.6 billion to $10.1 billion.
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So if GM spends $9.1 billion on capex this year, it will need to generate more than 20% of that number is increased cash from operations (since that’s a pre-tax number). If GM delivers, operating cash flows would jump well over $1.82 billion (20% of $9.1 billion) — an increase of 17%. For an old-line manufacturer, that would be an outstanding result.

If GM can earn 20% on new investment, it’s somewhat surprising that the automaker can’t find plenty of profitable uses for the money its now allocating to dividends and buybacks. Still, the promise to watch is the 20% commitment. If GM gets there, shareholders are likely to reap capital gains that would also justify buybacks, since today’s price would look cheap. How this one unfolds will be one of the most fascinating spectacles of 2015.