General Motors reported disappointing earnings yesterday and share price fell over 11% (compared to about 3% for broader markets) to $22 and change, down 33% from its IPO offering at $33 about a year ago. Taxpayers saw a paper loss of over $1 billion on their "investment" in just one day. Individual investors may have been confused by initial headlines that trumpeted an earnings beat by GM at the same time that pre-market share price signaled that the earnings report was a disappointment. Let's take a look at what drove the move as well as where GM may be heading.
Many of the same overhangs on GM remain from the time I wrote a piece on the risks back in March of this year. One of the risk factors I mentioned was weak European operations. That was at a time when GM was trading at around $31 and most analysts and pundits were screaming, "Buy, buy, buy!" Losses in Europe (and more importantly probability of continued losses) were given much of the blame for the latest drop, but there is more to the story than just European operations alone. Markets tend to look forward, and the prognosis is not great for future earnings growth at GM.
GM gave guidance on fourth quarter earnings that will see no growth over the prior year. This is the main reason share price suffered as analysts will now reduce estimates for the quarter. In my opinion, one of GM's problems has been that they have over-promised and under-delivered in many areas acting as if they were running a political campaign rather than a publicly traded company. Many observers have been suspicious that previous quarters' earnings were somewhat bolstered by inventory channel stuffing. Non-operating income helped drive past earnings as well. Actions like these can help support share price and positive perception short term, but eventually the piper must be paid. So, consider the third quarter set-back a partial repayment.
Other notable numbers reported include free cash flow, which dropped from 1.4 billion dollars last year third quarter to just 300 million dollars this quarter. Operating margins fell from 6.7% to 6%. Earnings from the China region were OK, but not overly impressive at $400 million, less than a fifth of North American numbers, which were probably the brightest area of the report coming in at about $2.2 billion. European operations lost about $300 million and South America was also a disappointment, finishing flat.
Another major area of concern for GM shareholders is pension and benefit obligations. This is a number that is often misrepresented with the number reported by the media only representing US pensions. Total pension and post-retirement benefit obligations for GM are listed as over $27 billion. GM also did not give any updates to the condition of pension plans. UAW overhang has been a concern for some time at GM.
Looking out to the future, there are other risks factors that I mentioned in March that are still being over-looked. GM is growing its captive financing arm but still relies on government owned Ally Financial for the majority of retail and showroom inventory financing. There may not be a risk to GM shorter term as President Obama is unlikely to exit Ally Financial and put GM at risk before 2012 elections, but remember that markets look to the future, and GM needs to be weaned from the government's financing teat.
The risks of analysts' downgrades remain and are now greater than ever. Investment banks like Morgan Stanley that proclaimed GM to be the best stock pick in the Universe may want to regain some credibility by reevaluating its rating. Treasury may also decide to sell shares on the open market rather than through offerings, which will not only weigh on share price, but negate the vested interests of underwriters to maintain buy ratings on GM .
Perhaps the greatest risk to GM's success is the focus of its current management. During opening remarks of the earnings conference call, Obama appointed CEO, Dan Akerson, once again pointed to electric vehicles and the Chevy Volt as a major bright spot for GM. Money managers and investors seemed to be more concerned with profits rather than GM's efforts to save the planet from global warming with share price falling as the continued hyping of EVs is doing nothing to help the company's bottom line. Bizarrely, the company continues to view the transition of sales from higher profit trucks to lower profit fuel efficient vehicles as a positive development. Again, GM is acting more like Government Motors than it is a publicly traded company with obligations to shareholders.
Despite the risks to GM, the major driver of the company's success or failure will be the economy. If a recession is avoided and consumers meet the optimistic sales forecasts for auto sales, GM and competitors should do fine. Individual investors should remain cautious, however, and be aware that GM is a speculative and highly cyclical investment. The industry is very competitive and if auto sales suffer a setback, as could happen in a double-dip recession, GM is not poised to whether the storm (without continued government support) over a longer period. $50 billion of taxpayer money buys a lot of time, but the amount is not infinite.
A lesson should be learned regarding the credibility of hype on publicly traded companies coming from those who have vested interests. Claims of future P/E ratios that seem too good to be true often disappoint. The promises might not pan out and an open mind and ear should be kept on contrarian views. Stocks can go up or down regardless of the perceived credibility of sources implying an investment is a sure winner. That is the reason Treasury should get the US taxpayers out of GM and stop playing market timer by gambling money that is not theirs to risk.
Mark Modica is an NLPC Associate Fellow.
