Wednesday, 13 February 2008

Company Focus - GM - Nearing the Positive Tipping Point

For the majority of long-term GM investors the reporting of its Q407 and CY07 results will have been as expected, the headline good news that it was the ‘exception’ of a $38.3bn tax charge seen in Q3 that caused much of the red-ink. Exclude this and it hopes to convey the message that the situation is improving to the point of near operational break-even – only $23m short.

The same underlying ‘healthy before tax’ story applies for GM Europe demonstrating a $55m operating profit before a comparatively massive tax hit resulting in a $524m loss. GME hit hardest in the 4th quarter as local consumer sentiment declined and a strong € maintained. Even so the not so hard to read-between-the-lines message is that there was a considerable near 9% increase in unit sales (totalling 2.2m units), even with a German orientated softer Q4. Opel/Vauxhall and critically Chevrolet (GMDAT sourced) compact and small cars contributed greatly to an increasingly attractive product mix.

The future replacement of Meriva with the far more design-flair ‘Corsa+’ raises hopes for additional GM fire-power in this important sector. Countering this success is the evident slow turnaround of SAAB and greater expectations from compact (Astra), mid-size (Vectra) large (Signum) cars – this last especially so - which though stylistically handsome have perhaps been let down by the badge snobbery, fine competitor products and a discerning and promiscuous marketplace. So it must be said that Russelsheim HQ, Strategy & Design still has much to do to increase the attractiveness regards higher margin products to maintain profile in mainstream markets. The Solstice based new GT sports assists as a halo product to a degree, but the cars need to better stand-up for themselves. As for LCVs, the Renault sourced Vivaro and ageing Combo don’t assist brand clarity and whilst undoubtedly provide plausible margins, more must be done to align LCV vehicles with themselves and the Opel brand at large if it wishes to steal share from PSA and Fiat.

As for GM North America, not much surprise as the search for operational break-even proves elusive in such harsh conditions, though traction is being created. The slightly improved operating loss of $1.5bn (beating last year’s $1.6bn) once reported after tax being $3.3 (vs $7.5bn reported for FY06, critically excluding special items, that probably make the improvement gap appear greater). Usual headwinds [commodity prices, FX rates] were accompanied by the much needed dealer stock and rental sales reduction initiatives; but reportedly countered by a stronger product mix engendering higher pricing and greatly reduced manufacturing and legacy costs – the hard-won outcome of previous initiatives. Keen to point-out the consistently improved revenue per vehicle (based on non-GAAP principles) – as part of the major structural change ideal since 2005 – this important measure of effective productivity can be seen to contribute to North American 2007 and beyond investment levels. The year on year picture of improved Net Revenue per Unit* looks like:

2007- $21,487
2006 -$20,189
2005 -$19,425
2004 -$19,417
2003 -$19,160

Of course to quote GM “revenue per unit = gross revenue less sales incentives”, but as we know whilst the direct costs of obvious price discounting has been apparently
contained, the truth is that the demands of the market saw increased non-price incentives with the inclusion of ‘thrown-in’ feature deals and (esp Q1-Q3 2007) the ease of credit terms stretched. So whilst Revenue per Unit appears consistently improved, we suspect the in-direct real costs don’t flatter to the same extent.

The launch of a new core product in the shape of Malibu will have improved the mix for 07 & 08 enormously, dealers knowing the extent of Detroit pressure and regards their own profitability, keen to rapidly replace old stock with the new car. This was, we believe, implicitly well understood by GM management & their dealerbase, who knew that Malibu uptake was (probably) a key measure by which to judge those ‘committed’ dealers set against the context of the network rationalisation programme.

But of course the pace and pressure of change within GMNA is critical if it is to maintain progress of structural change required to instill stakeholder confidence, the key measure/metric offered that of Structural Costs vs Revenue; driving down from 34% in 2005 to an eventual 23% in 2012; much dependent upon release from pensions and health costs and the ability to fully implement the ‘letter and spirit’ of the recent UAW flexibility agreements.

Also relative to NA is the ongoing Delphi re-structuring, and GM’s obvious interest, highlights the possibility of Delphi not securing the required support needed from the financial markets, raising the prospect of GM bring the firm back into the fold once legacy costs have been negated and possible UAW membership buy-outs occur. This would leave a buoyant entity either able to assist GM Auto by incurring greater transfer pricing costs as a strong, comprehensive corporation, or possibly see the spin-off of specific low-value divisions and plant to foreign supplier with NA expansion plans. This saga has yet to play out but much will depend, we suspect, on the possible Democrat Government decision to back inward investment to aid an auto-industry recovery, or at the very least offer tax incentives to re-integrate elements of the US supply chain into VM structures.

Demonstrably, the central pillars of positive earnings came from the emerging nations represented by GLAAM and GMAP divisions.

GLAAM demonstrated a stellar 19% improvement in units sales to 2.1m, improving revenues by 50% and earnings (BT) to a near 500% for Q407 YoY; thanks to a 1% market share growth in Brazil and 2% for Argentina. GM (Chevrolet) is well positioned in these markets with a strong range of mid-point vehicles vs Ford’s good but ‘thin’ portfolio, Fiat’s older, broader but ‘sporadic’ range, Honda’s & PSA’s ‘targeted’ small range, Renault’s 4 cars, Toyota’s Corolla and VW’s limited but high volume small & compact family. Hence GM has a good portfolio to benefit from continued market expansion, even if probably not up to Ford’s well managed 15% margin achievement in the region (thanks to ‘thin’ small car range and high contribution from F-series trucks)

GMAP, representing an oft considered the ‘golden goose’ region demonstrated the reality of sustaining auto-operations, with a post-tax income of $681m, down considerably from 2006 at $1.2bn. However, this does (as stated) demonstrate the high confidence in the region, the results highlighting the substantial level of regional investment. As expected the Chinese JVs and Holden proferred much of the contribution given the respective continued product & volume expansion in China and improved margins made at Holden via GMDAT sourced vehicles. The output and success of GMDAT products demonstrated the success of a generic multi-regional (effectively global) vehicle line that has set the corner-stone of Chevrolet expansion outside NA. Having incurred great financial and structural strain with the absorption of Deawoo the strategic results are clearly being demonstrated.

The question from here-on in, is obviously the speed at which GMDAT can itself be disseminated into Indian and Chinese operations, benefiting from a decoupling from the higher-cost supply base in Korea. Perhaps the Chevrolet regional ‘benchmark’ is the somewhat dated, but highly integrated Tavera which boasts 98% local content. Based on the previous Isuzu Panther, the local supply industry has simply reproduced the required component sets. GM will be assisting Indian suppliers to possibly to the same with the under-the-skin parts for next generation Aveo, SRV, Optra to both assist local sourcing and of course assist ex-factory pricing.

But of course China stays in the limelight with GM’s “explosive growth” of 20% (generally in line with market expansion). Management seeks to grow with 5 new products over Cadillac, Buick, Opel, Chevrolet & SAAB offerings, capital expenditure rated at $1bn pa to 2010.

GMAC’s 20% improved auto-financing performance was understandably dwarfed by ResCap losses of $4.3bn, $2.3bn attributable to GM with its 49% holding. Cerberus’ buy-in and 51% stake assisted backed liquidity at $22.7bn, a substantial reserve that will underpin GMAC’s re-structuring and re-newel, ready for the housing market upturn expected in 2010.

investment-auto-motives believes GM, Cerberus & GMAC could lead the way in setting a new profitability model relative to the consumer investment relationship between housing and vehicles. This is an arena that deserves full and proper investigation to enquire as to how their fiscal relativity (in terms of consumer perspective and purchase cycles) can be best exploited to serve auto-makers and their affiliated finance division. We previously reviewed such possibilities in an earlier essay (see 03.01.08: Macro Level Trends – Remodelling the Structural Economics of Autos & Housing), but at this crucial juncture of ResCap & GMAC re-structuring all stake-holder parties should ‘explore to exploit’ – the obvious being the integration of 3/5/7 year auto-loans into what will probably be longer-term residential loans.

To summize…

GM is back on course, though slower in practical progress than originally intended by Wagoner and the Board. 2007 saw successful UAW talks which will deploy continued benefits shortly that even with a deflated US market should improve profitability in due course. However, it is critical that at this time, a broad span of creative strategic solutions are sought across the board, from R&D to design and development (replicating GMDAT success) to the global platforms ideal to protected flexible manufacturing methods that allow generic products to latterly spawn into possibly more regionally succinct vehicles as the markets demand greater regional consumer-connected sensitivity. Of course, the balance is to find the mid-point of variability vs margin maximisation, but such considerations will come in due course.

For the moment the fundamentals of the business are indeed being put right, even if, under these turbulent times, the jittery financial markets may have over-discounted corporate valuations. From here on in the key will be for the charismatic Wagoner to maintain investor confidence over the short-medium-term, until western economic buoyancy returns. And a few more structural alterations in GM’s rebuild (like a part absorption of a stronger Delphi or acquisition of international prime dealers) may well assist.