Amid the Recalls, Can General Motors Persevere?

General Motors (NYSE: GM  ) has had a rough start to 2014. The past five months have been one recall after another, and now the company is facing billions in recall costs. As the legal fees pile up, GM is struggling to regain its footing. Not only are the recalls causing financial headaches, but also damage to GM's brand and reputation. Investors are wondering if its time to cash in. Can the automaker climb out of this recall nightmare?

The total number of vehicles recalled by GM this year tallies roughly 16 million... so far. Numerous makes and models were taken off the streets for problems including faulty ignitions, seat belts, transmissions, and assembly. A recent recall occurred in mid-May, adding 2.42 million vehicles to GM's list of emerging safety issues; however, according to the National Highway Traffic Safety Administration (NHTSA), GM's recent roster is not among the biggest auto recalls ever.  

Then there are the legal proceedings. General Motors' CEO Mary Barra has spent the past several weeks battling atop Capitol Hill. Despite her efforts, General Motors was assessed a $35 million fine. The company will also pay civil penalties for delaying proceedings during the NHTSA's investigation involving its faulty ignition switches. 

But is there an upside for the burdened auto manufacturer?

What does this mean for GM?
General Motors is affected by its current situation in two ways: by the books and by market expectations.

The first-quarter filings tell a less than ideal story. Through April 24, GM's net income was a mere $300 million -- compare that to its 2013 net income of $1.2 billion in Q1 of 2013. Many of the recall costs are eating GM's profit. Two other downsides involve GM's return on equity, or ROE, and the earnings per share, or EPS. Again, both are well below their 2013 values. However, GM is not alone. Ford's  (NYSE: F  )  ROE and EPS were also below last year's Q1 values. 

Ford's net income trailed its 2013 figure due to an increase in warranty reserves (from safety and product campaigns) and premium weather-related costs. Ford expects to reach a pre-tax profit of $7 billion-$8 billion in 2014.  

All of this boils down to one thing: less value for shareholders.  

The market is also voicing its concerns. Since the first recall on January 13, General Motors' share price has dropped about 15%. Also, two of its major players reduced their stakes -- Berkshire Hathaway and Greenlight Capital dumped a combined 27 million shares. Greenlight Capital released all of its 17 million shares shortly after GM's Q1 recalls.  

Investor confidence and brand reputation are dwindling in light of GM's recall nightmare. GM took longer than a decade to address the ignition switches, which are tied to at least 13 deaths (investigations are still under way). Appropriately, GM looks more and more like a careless, corporate giant. The question regarding GM used to be, "Which models have been recalled." Now, the question is better rephrased as, "Which models haven't been recalled."

GM must prepare for a long fight.  

Staying on the bright side 
Thankfully for General Motors, further legal damages are limited by its 2009 bankruptcy. Its Chapter 11 filing discharges a majority of its debt, including potential lawsuits, for all incidences before July 9, 2009.  As a result, GM is protected from paying most damages (injuries to persons and damages to vehicle and/or property) connected to its recalls, along with other civil suits. Even still, Barra has retained Kenneth Feinberg -- a specialist in mediation and alternative dispute resolution -- to evaluate settlement options for those families hurt in accidents by the company's recalled vehicles. As Barra stated, "Mr. Feinberg is highly qualified, and is very experienced in the handling of matters such as this." Smart move.  

And despite its seemingly poor performance, General Motors managed to increase its revenues from 2013 by $500 million while increasing its automotive adjusted free cash flow by $1.1 billion (comparing Q1 of 2013 to Q1 of 2014). This is largely due to growth in its European and international operations segments, which experienced moderate increases in their retail vehicle sales since last year. The higher adjusted free cash flow but lower net income is explained by a $4 billion increase to accounts payable. GM has more cash as it becomes slower at paying its bills.   

In the United States, GM controls 14.8% of the market for cars, an increase of 1% since 2013. Barra was pleased with the company's performance, saying that, "Our core operations was very strong this quarter, reflecting the positive response of customers to the new vehicles we are bringing to market." The 1% increase helped to raise North American sales by $1.4 billion this past year.  

GM's market share is also expanding in Asia-Pacific, Middle East, and Africa. Its Wuling, Buick, and GMC brands increased GM's volume of sales by approximately 9% in these regions last year. In China, Asia's largest market (by sales), GM is second to only Volkswagen which owns 20.8% of the passenger car market. Expanding international market share will aid GM in rebounding from its recall costs and to accommodate future growth. 

Final thoughts
There is no denying that General Motors is in a tough spot, but it appears it is in a position to turn things around. With protection from its 2009 bankruptcy, GM can mitigate losses from the recalls and take advantage of increases in market share, both in the U.S. and internationally. Furthermore, once recall costs no longer drag down profits, investors should see growth and a healthier balance sheet. Surprisingly, despite the recalls, GM is managing to keep its head above water. Investors should sit tight: This Detroit giant still has some fight left.

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