Earnings Preview: China Growth to Drive GM’s Earnings

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General Motors

General Motors (NYSE:GM) is scheduled to announce its Q2 FY14 earnings on July 24. In the first quarter, GM’s earnings were down on account of high expenses related to car recalls and unfavorable currency translations. However, a slight increase in the number of units sold, primarily due to higher sales in China and Europe, and higher average vehicle prices led to an increase in the company’s revenues. Over the quarter, the company recalled another 2.6 million cars raising the total number of car recalls in 2014 to 15.4 million. However, car sales have remained unaffected and have even shown marginal increases in some regions. Our note below discusses the factors we will be watching out for in the upcoming earnings report for the company.

We have a $40 price estimate for General Motors, which is about 18% more than the current market price.

North American Operations Steady

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North America accounts for about 35% of the company’s unit sales. In the first quarter, the volumes sold suffered due to the limited availability of GM’s full-size SUVs, but a favorable pricing mix of $1.7 billion driven by the launch of full-size trucks Cadillac CTS and Chevrolet Impala pushed the company into profitability over the quarter. [1]. With another 15 models to be refreshed or introduced this year, margins as well as unit sales should continue to remain strong. Furthermore, a slew of model refreshments under the Chevrolet and Cadillac brands have pushed up the average pricing and helped GM realize higher margins. Through the four quarters of 2013, the North American operating margins rose 60 basis points to 7.8%, spurred by the Chevrolet, Buick, Cadillac and GMC, with all increasing their retail market shares in North America. [2]

During the first quarter of 2014, the cost of recalling 6.3 million vehicles worldwide, including 2.6 million cars in North America due to a faulty ignition switch put a dent in the company’s profits. The company had to recall 7.6 million more cars because of the same fault in its cars over the second quarter and expenses related to these recalls should affect the bottom line. [3] In the first quarter, the company incurred c0sts of approximately $1.3 billion, up from $750 million previously, mostly due to the cost of recall-related repairs and providing free loans to customers. [4] In this quarter, the costs should be about half that amount. The company has guided for $1.2 billion, but the figure includes a $700 million charge already disclosed in the first quarter. Also, following the shutdown of GM’s factories in Venezuela, which had been affected by currency issues, the company’s earnings should come in higher than the previous quarter.

European Operations Could Improve

Europe has been a worry not only for GM but for a number of other automakers as well. Most automakers have been relying on sales in China and North America to offset sluggishness in Europe. However, car sales in western Europe have recovered from its six-year slump. In the first half of 2014, car sales have increased by around 7% compared to the same period of 2013. A particular item of good news for GM was the spike in sales of GM Europe’s Opel-Vauxhall subsidiary, which recorded a sales growth of 4.2% despite dumping its Chevrolet brand. [5]

The European automotive market was in a free fall till 2012. The market was in red till the first half of 2013, but things improved in the second half of the year. Now with the market rising, there is once again a renewed optimism about Europe. GM plans to release 23 new or refreshed models by 2016 and hopes to become profitable in the region by the mid-decade.

Chinese Sales Should Remain Strong

China is GM’s largest automaker and accounts for about 35% of the company’s unit sales. In Q1, GM’s unit sales set a record pace reaching a million units as early as April. In addition to the mainstream car and van segment, in which GM has a significant presence, the automaker is also looking to bolster its presence in the luxury car market. Earlier in 2013, GM got the government’s approval to build a $1.3 billion plant with a capacity to churn out 150,000 units of Cadillac cars locally. Until now, GM use to sell imported Cadillacs in China, as a result of which, prices inflate due to the high tariffs imposed on imported vehicles.

With the help of lower prices, GM is targeting a 10% market share in the Chinese luxury market by the end of the decade. That could translate to more than 250,000 units annually just from the sale of luxury cars. If the proportion of higher priced vehicles rises, we could see a healthy increase in the average equity income earned per vehicle. Volkswagen overtook GM as the largest automaker in China in 2013, but GM is working to regain its position as the market leader in the country. The automaker has plans of building five more plants in 2014, in an effort to increase its manufacturing capacity by 65% by 2020. GM expects its China sales to grow by 8-10% this year, in line with the overall growth of the Chinese market. [6]

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Notes:
  1. General Motors’ CEO Discusses Q1 2014 Results, Seeking Alpha, April 2014 []
  2. GM 10-Q []
  3. General Motors Recalls Another 7 Million Vehicles, Some Dating Back To 1997, Forbes, June 2014 []
  4. GM Recall Costs Soar to $1.3 Billion, Forbes, April 2013 []
  5. Europe Car Sales Boom, Forbes, April 2014 []
  6. GM To Battle Volkswagen In China with $12 Billion Investment, Reuters, April 2014 []