Earnings Review: Car Recall Expenses Hurt GM But Core Performance Still Strong

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General Motors

General Motors (NYSE:GM) released its second quarter results on July 24. The company managed to retain strong core performance despite incurring heavy expenses related to car recalls and unfavorable effects of currency translation. Net Revenue for the quarter came in at $39.6 billion, slightly higher than the same figure in the previous year’s second quarter. The increase of $600 million was attributable to the effects of a favorable sales mix, higher average pricing and increased revenue from GM’s Financial Division, partially offset by lower wholesale volumes and the negative impact of the translation of the Brazilian Real and Argentinian Peso to the U.S. dollar. [1] Car sales were up in the U.S. and China, the two biggest and most profitable markets for the company. However, weak performance in the under performing markets of Russia and Venezuela, and the closure of the operations of the Chevrolet brand in Europe led to a 0.3% reduction in global market share. Special charges of $1.3 billion and $1.2 billion worth of recall related expenses meant that the company lost $500 million on an operating basis over the quarter. [2]

We have a $40 price estimate for General Motors, which is about 15% more than the current market price. We are in the process of revising our estimates in order to incorporate the latest earnings.

North American Sales Unaffected By Car Recalls

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GM North America’s (GMNA) revenues came in $2.2 billion higher at $25.7 billion compared to the second quarter of fiscal 2013. [1] This increase of close to 10% was driven primarily by higher average unit prices in the region. The company’s market share in the continent stood at 17.2%, flat versus the market share in last year’s second quarter but up 0.9% from the first quarter, with a 17.9% share in the U.S. [1] Excluding the impact of recall expenses, GMNA’s operating margin was above 9% for the quarter and up 1.15% for the first six months of the year compared to the same period in the previous fiscal year.

There were fears that the negative publicity associated with the car recalls over the faulty ignition switch incident but core operating performance remained unaffected over the quarter. Excluding the impact of car recall related expenses, GMNA’s earnings before interest and taxes were up by $1 billion, on the back of an increase in wholesale unit volumes, a favorable sales mix which included the company’s full-size trucks and Corvette stingray, and higher average transaction prices. The company spent $1.6 billion over the quarter on car recalls, resulting in a net loss of $600 million before interests and taxes. [1]

European Restructuring Underway

GM’s European operations were unprofitable as expected due to restructuring related expenses. However, the company’s subsidiary Opel Vauxhall showed continued strength in the region, with sales increasing 4% and market share increasing by 0.08% year-to-date. [1] Even though GM’s overall market share in the region is down to 6.8% due to the shutdown of Chevrolet’s European operations, its overall market position in Europe is improving and this effect can be directly attributed to Opel Mokka and Insignia, the company’s new flagship brand. The company is planning to undertake investment well in excess of $5 billion over the next few years in order to develop 27 new cars and 17 new engines under the Opel brand, which will start offering budget cars for the first time under its nameplate. [3] GM’s market share in the European car market has shrunk from 10.4% in 2008 to 6.8% in the present quarter, a major decline when you factor in the 23% decline in the market size over the same period. The U.S. based auto maker is trying to restructure its European operations in order to return to profitability by 2016 and aims to reach a 5% operating margin by 2022.

Record Sales in China

GM’s sales in China were up 8% for the quarter and the net income margin improved by 0.6% to reach 10% for the quarter. [1] The automaker’s share of the world’s biggest auto market stood at 14.4% for the quarter, flat versus the share in the same quarter last year. [1] GM’s market share is due to the growth in the company’s Cadillac, Buick and Wuling brands. The company also expects the sales growth rate of Chevrolet to catch pace in the future as sales of the new Trax crossover gather steam. Crossover and SUV demand in China is expected to grow at about a 10% annual rate and reach about 7 million units by 2020. [4]

GM is now looking at the luxury car segment in China, since it already has a significant presence in the mainstream car segment. Last year, GM got the government’s approval to build a $1.3 billion plant with a capacity to produce 150,000 units of Cadillac cars locally. With more competitive pricing, GM is targeting a 10% market share in the Chinese luxury market by the end of the decade. As the proportion of the higher priced vehicles increases, average income earned per vehicle could rise even further.

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Notes:
  1. General Motors’ CEO Discusses Q2 2014 Results Earnings Call Transcript, Seeking Alpha, July 2014 [] [] [] [] [] [] []
  2. GM 8-K []
  3. GM Pulls Chevy From Europe After Decade as Opel Expands, Bloomberg, December 2013 []
  4. China And Other Emerging Markets To Drive SUV Demand, China Economic Review, February 2014 []