Earnings Preview: Excellent U.S. Performance Should Result In Strong Profits For GM

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General Motors

General Motors (NYSE:GM) is scheduled to announce its Q4 FY15 earnings on February 3rd. In the third quarter of FY15, the company reported earnings of $0.84 per share, a minor improvement over last year’s $0.81. ((GM 10-Q SEC Filing, GM Investor Relations)) Rising sales of full-size pickups and SUVs drove margins in North America, while higher unit sales drove revenues in China. Europe showed signs of recovery while South America and Asia Pacific continued to disappoint due to macro economic weakness in the market. We believe the company to continued its strong momentum in the fourth quarter. The Detroit-based auto maker sold 9.8 million vehicles in 2015, a 0.2% increase compared to 2014. The company grew its sales at a rate of 5.2% in China, selling 3.61 million vehicles, and a 5% gain in the U.S., selling 3.1 million units.

We have a $41 price estimate for General Motors, which is about 40% more than the current market price.

North American Should Remain Strong

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North America accounts for over a third of the company’s overall unit sales. In the third quarter, the company made $3.3 billion before taxes in North America. Three factors drove the company’s profitability in the third quarter: 1) its retail market share grew by 110 basis points; 2) its market share in the mid-size and full-size pick-up truck segment increased; and, 3) the Chevrolet Silverado and GMC Sierra together outsold Ford’s F-150 for the first time. [1] Additionally, expenses on the compensation fund for the faulty ignition switches have now reduced and GM continues to realize higher revenues from the leasing of vehicles as interest rates have remained low.

In the fourth quarter, GM’s bottom line likely benefited from the introduction of the new versions of the Chevrolet Malibu, Chevrolet Cruze, Camaro and Camaro convertible. The new vehicle launches likely also helped the company realize higher than usual transaction prices. However, the company will also incur the costs of the roll out of these new models and the slow ramp up to full volumes. This could affect profitability in the quarter but full year performance should remain strong on account of the strength in the first three quarters of the fiscal year.

European Losses To Narrow

GM, like Ford, has been losing money on its operations in Europe. The Detroit-based auto maker has been undertaking the restructuring of its business in Europe. Company management expects European operations to return to profitability next year. In the previous quarter, the company’s losses in the region narrowed to $200 million compared to $400 million in the third quarter of 2014. [1] Earlier this year, GM decided that it would stop selling its Opel and Chevrolet vehicles in Russia, a market that the company was previously expecting considerable growth from and its third biggest market in the continent. Additionally, the company also shut down its factory in St. Petersburg and took a one-time special charge of $600 million as a result.

However, the company should benefit from cost cuts and the launch of new vehicles, like the latest Astra compact car which went on sale in October. According to GM’s Europe division’s CEO Karl-Thomas Neumann, the company’s Opel/Vauxhall brands have been earning higher margins than usual this year, as consumers have been opting for more than usual optional equipment. In 2015, Opel achieved its best sales results in four years, selling 1.1 million units, a growth of 3.3% compared to the previous year. [2] The growth rate was higher than the industry wide growth rate. Consequently, we expect that the company’s losses narrowed further in the fourth quarter. However, full year results are likely to be negative.

Lower Purchase Tax Should Help Overcome China Slowdown

China is GM’s largest auto market and accounted for 36.7% of the company’s unit sales in 2015. In the previous quarter, GM’s China unit earned $500 million in equity income for the quarter, raising its pre-tax profit margin to 9.8%. [1] GM sold 3.61 million units in China for the full year, a 5% increase compared to its 2014 performance, despite enduring several months of sales decline. [3] The company posted gains of 14% in the last two months of the year, benefiting from the reduction in the purchase tax on vehicles in China. [4] In 2016, the company is planning to launch 13 new or revamped models in the region as it looks to overcome the slowing economic growth in the region. These models include the Cadillac CT6, Malibu XL and Cruze XL. Industry wide sales in China grew at only 3% in 2015, but China automakers association has forecasted a 5%-7% pace for 2016.

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Notes:
  1. Ref: 1 [] [] []
  2. GM Europe aims for profit this year after 2015 loss, CEO Neumann says, Auto News, January 2016 []
  3. GM China auto sales rise 5.2 percent in 2015, Reuters, January 2016 []
  4. Ref: 3 []