Two Things Investors Are Overlooking In GM’s Recent Earnings Report

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General Motors

General Motors (NYSE:GM) had a tough first quarter of fiscal 2015 reporting an adjusted earnings before interest and tax (EBIT) of $2.1 billion and an EPS of $0.86. [1] The results disappointed investors and the stock fell by 3% on Thursday. It is important to note, however, that the major factors driving down the company’s profits were negative effects of FX translation, pulling operations out of Russia, and an increase in the contribution to the fund for the ignition switch compensation program. [2] These factors are not representative of the underlying business and it is not possible to make inferences about long-term trajectory from these events. However, there were other factors which a number of people missed, that can be used to make inferences about the path the company is on, and they were mostly positive. Below, we take a look at two such factors.

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

Higher Transaction Prices and Lower Incentives

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GM’s North America business is still the most profitable segment for the company contributing nearly all of the company’s adjusted EBIT. Interestingly, the company reported a seventh consecutive year-over-year increase in adjusted EBIT in the region, this time even as it lost market share. [3] The propelling force behind the company’s increasing profitability in the region was the higher sales of SUVs and pick-up trucks in the U.S.  Together, the two segments boosted GM North America’s operating profits by around $500 million. [3] These segments contribute higher margins and it is no surprise that their rising contribution to the sales mix led to higher profitability. However, GM North America overall reported an increase in average transaction price of close to $2,000 compared to the first quarter of last year. [3] With incentives lower and average prices higher, the company reported a higher profit despite lower unit sales. Moreover, unit sales were lower as the company is set to refresh the Chevrolet Malibu and Cruze and Cadillac CT6 later this year. [3] The new models will help raise sales, and if the company can keep the trend in higher prices and lower incentives going, it can post higher profits.

Another factor driving down the company’s profits was the $600 million headwind in carryover pricing in the secondary market. [3] Starting late last year, GM started controlling the supply of its vehicles at used car auctions. The limited supply raised prices temporarily but some of the inventory had been held back for too long and their prices lowered as they aged. The company will have to find some way to optimize this process going forward, or it can be a constant source of drag on its profits.

Resurgence of GM Financial

GM’s Financial division (known before as Ally Financial) once used to be even more profitable than Ford Credit. However, the company’s bankruptcy forced the two to sever ties. In recent times, the company is looking to reinvigorate its finance division and results are beginning to look good. In the first quarter of fiscal 2015, the percentage of retail sales using GM’s Financing Division grew to 28% compared to 19% in the first quarter last year. [3] This made the division the third most profitable business segment for the company. [4] Moreover, this figure is expected to grow quickly and thus contribute even more to profits going forward.

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Notes:
  1. GM 10-Q, SEC []
  2. General Motors’ (GM) CEO Mary Barra on Q1 2015 Results – Earnings Call Transcript, Seeking Alpha, April 2015 []
  3. Ref: 2 [] [] [] [] [] []
  4. Ref: 1 []