Earnings Review: Recall and Restructuring Costs Hurt Profits But Record Sales In China Point To a Bright Future For GM

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General Motors (NYSE:GM) announced earnings for the fourth quarter of fiscal year 2014 on February 4. The company reported a loss of $0.66 per share despite improved core automotive performance. [1] Incremental car recall and restructuring costs put a heavy load on the company’s bottom line and resulted in the loss. For the full year 2014, the U.S. based auto maker reported a full year net income of $2.8 billion, down from $3.8 billion in 2013. [2] Revenue for the full year increased to $155.9 billion compared to $155.4 billion in 2013, but heavy expenses related to car recalls, and restructuring of operations in Europe and South America, meant that the reported earnings per share was down from $2.38 in 2013 to $1.65 in 2014. [2] Digging deeper into the numbers, there are several things to be positive about as far as the future prospects of the company are concerned. The company posted record sales volume and market share in China and higher sales and stable market share in North America. Additionally, the company has posted gains in pre-tax income in South America for three consecutive quarters, and the operating performance of Opel, GM’s main vehicle brand in Europe, excluding the economic decline in Russia, has improved. The U.S. based auto maker also posted a second consecutive year of record sales volume, having sold 9.9 million light vehicle units in 2014. [2] Below, we take a closer look at the earnings report.

We have a $40 price estimate for General Motors, which is about 10% more than the current market price.

GM Holds Firm On Its Strong North America Base

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GM increased its unit sales in North America by nearly 6% to 20.2 million units compared to 19.09 units last year. The company’s Chevrolet brand had an excellent year, with sales up 5% for the year on the back of the good performance of new models like Silverado, Tahoe, Colorado, and Suburban. Over the year, the company retained a market share of 16.9% for the region. [3] However, its market share in retail sales increased by 0.4 percentage points, led by sales of all new midsized and full sized trucks, as well as full-size SUVs. The company’s market in full-size SUV trucks increased by as much as 5 percentage points from a year ago to 41% for the fourth quarter. [4] The company achieved this through a mix of new model introductions and slightly higher than industry average incentives. GM’s incentives were about 11% of average transaction price for the quarter, about 10% higher than the industry average. [4]

In the fourth quarter, the company posted a pre-tax income growth of around $300 million from its North American operations. Nearly $100 million of this growth was contributed by a 14,000 volume decrease in wholesale volumes. [4] Additionally, the company managed to achieve a $400 million upside due to higher average transaction prices. [4] This happened because of the following reasons: When vehicles are retired from rental fleets, they are sold on the used car market in auctions. The price that a car company fetches for these vehicles depends quite a lot on their supply. An oversupplied market means that the average transaction price for a retired-from-rental-fleet model is usually quite low. Due to poor management of its fleet business, GM did not do very well in this area. However, in November, the number of GM vehicles available at auctions was as low as 70 compared to about 800 in October. [5] By temporarily cutting sales of these retired fleet vehicles, GM was able to restrict the supply of these vehicles into the used car market. If the company had not done so, consumers would have been able to buy these cars from dealerships which bought these cars cheaply at these auctions.

European Restructuring Underway

GM’s European operations were unprofitable as expected due to restructuring related expenses and weak volumes in Russia. However, the company’s subsidiary Opel/Vauxhall showed continued strength in the region, with sales and market share increasing in 12 countries for a second consecutive year. Even though GM’s overall market share in the region is down to 6.3% 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. [4] 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. [6] GM’s market share in the European car market has shrunk from 10.4% in 2008 to 6.3% 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 12% for the quarter (year-over-year comparison) and its share of the world’s biggest auto market stood at 14.8% for the quarter, up 0.6 percentage points from a year ago. [7] GM’s market share is due to the growth in the company’s Cadillac, Buick, and Wuling brands. Global Cadillac sales increased 5% on the back of a 47% increase in China, bringing the cumulative sales growth of the brand to 35% since 2012. [4] Chevrolet also achieved a record sales figure as volumes of the new Trax crossover gathered steam. [4] Crossover and SUV demand in China is expected to grow at about a 10% annual rate and reach about 7 million units by 2020. [8]

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. GM Reports Q4 2014 Net Income of $1.1 Billion, GM, February 2015 []
  2. Ref: 1 [] [] []
  3. General Motors’ (GM) CEO Mary Barra on Q4 2014 Results – Earnings Call Transcript, Seeking Alpha, February 2015 []
  4. Ref:2 [] [] [] [] [] [] []
  5. Where are the GM program vehicles?, Automotive News, December 2014 []
  6. GM Pulls Chevy From Europe After Decade as Opel Expands, Bloomberg, December 2013 []
  7. GM 10-K, SEC []
  8. China And Other Emerging Markets To Drive SUV Demand, China Economic Review, February 2014 []