General Motors: Turned a Corner?
After a bumpy ride last year, General Motors appears, at first glance, to be turning around. The automaker made money in the first quarter of 2006 -- its first quarterly profit since 2004. Chief executive Rick Wagoner told shareholders at GM's annual meeting Tuesday that he wants the company to save $7 billion in its North American operations by cutting 30,000 jobs and closing nine plants. GM shares have risen 33% so far this year. You might think it's a good time to buy the stock. But kick the tires, and you'll find that conjecture of GM's imminent recovery may be just that -- conjecture. "Earnings improvements that do not generate cash are masking GM's operating weakness," says UBS analyst Rob Hinchliffe.
An accounting change saved the day for GM in the first quarter. The company earned $445 million, or 78 cents a share. But GM initially recorded a $1-billion loss in the first quarter as part of its contribution to a newly formed trust for retiree health care. Only an accounting change sanctioned by the SEC allowed GM to expense the cost of the fund over seven years, putting the company in the black for the quarter.
Various GM moves to cut costs -- trim its workforce, close factories and reduce employee benefits -- will move slowly to the bottom line. "None of the actions GM has taken so far will result in near-term operating cash savings," Hinchliffe says. The $4.3 billion in retiree health care and pension reductions won't affect cash flow until 2008, he estimates. Plant closing and buyouts will eventually help earnings, but the cost of those actions will offset savings right now.
GM's share of the worldwide car market has been sliding for 40 years. Don't expect this trend to change. The world's largest automaker may soon be eclipsed by Toyota, which, along with Honda, is a leader in fuel-saving hybrid cars. GM, on the other hand, is a leader in gas-guzzling SUVs and pick-up trucks -- not exactly an ideal position to be in when oil sells for around $70 a barrel. "Pickup-truck demand, which had been holding up relatively well until recently, appears to have taken a negative turn," says Deutsche Bank analyst Rod Lache, who recently downgraded the stock from "hold" to "sell." Moreover, rising interest rates make it more expensive to buy cars on credit, notes Lache.
Profitable Japanese and Korean automakers have better access to cheaper and more efficient labor. Health care costs are a huge part of that advantage. While GM has curbed retiree health care and pension costs, active full-time employees still have generous health benefits compared with other large companies, says Bernstein analyst Brian Johnson. "The hourly active health care plan lacks most of the cost reduction features other large firms have put in place over the last decade," he says. GM has a shot at lowering health costs during the next round of negotiations with the United Auto Workers, in 2007. Still, health care will be a major sticking point in the talks and "raises the potential for a crippling strike and bankruptcy as the UAW has yet to show a willingness to make wage concessions," Johnson says.
With all its troubles, analysts expect GM to turn a profit for all of 2006. Analysts surveyed by Thomson First Call expect the company to earn 95 cents a share this year. Recently at $25, the stock (symbol GM) trades at 26 times those expectations.
--Thomas M. Anderson