When management speaks, investors listen. It's about as simple as that. And when General Motors (NYSE:GM) calls an "Office Hours" conference call -- Monday, June 26, at 3 p.m. EDT -- investors would be wise to tune in and hear what the company has to say. If you're thinking, "Didn't GM just have one of these calls?" you'd be correct: on April 6, as a matter of fact. So, what's going on here, and should investors be concerned?
A trip down memory lane
Much of the focus of GM's April 6 call was on the company's risks and opportunities, the sale of Opel/Vauxhaull in Europe and the details that went into that development, and clarification of its rising inventory and incentives. We're likely to get more insight into those same developments this time around, but it's also possible that the peaking auto industry has put more pressure than we realize on Detroit's largest automaker. It's possible we're about to get a warning about GM falling short of its quarterly guidance, or more insight into used-car pricing pressure and if it's pressuring General Motors Financial (GMF).
We've already seen some moves from General Motors that hint toward a coming slowdown. In late January, GM canceled the third shift at its Lordstown, Ohio, small-car factory as sales of the Chevrolet Cruze sedan took a turn for the worse. The reason is simple: Consumers want SUVs and trucks, and GM wants to avoid using fatter incentives and discounts to sell sedans, so production cuts are necessary. In fact, GM has laid off more than 5,000 workers in 2017, and more will take extra temporary time off during the typical summer shutdown.
What's going on?
However, there's more to the bigger picture than consumers switching from sedans to SUVs and trucks. As that consumer preference switched and new technology drove prices higher in larger vehicles, consumers opted to lease vehicles at a higher rate. When all of those leased vehicles come off lease, it will flood the used-vehicle market with a surplus of vehicles, which is beginning to pressure prices.
One example was found this week in CarMax's (NYSE:KMX) earnings data. Despite CarMax's sales mix of vehicles increasing toward SUVs and trucks, rather than less profitable and lower-price sedans, its average selling price (ASP) of used vehicles dropped nearly 2% to $19,478. That drop accelerated sequentially from the fourth quarter, which posted a 1.6% decline in ASP.
Bank of America Merrill Lynch analyst John Murphy explains why this matters:
If the industry is not large enough to absorb the 3.5 million units coming off lease this year, we may see significant pressure on used-vehicle pricing ensue this year in a very material way and spike down the cycle faster and more furiously than even we're expecting.
Why does it matter?
Lower residual values and used-car pricing directly affects automakers such as General Motors and Ford Motor Company (NYSE:F) because both have large finance divisions -- Ford's is even larger than GM's. The automakers are forced to predict the returning value of the vehicles they lease, and if used prices and residual values deteriorate faster than anticipated, it immediately eats away at the bottom line. It's a bigger deal than many investors realize; consider that Ford Credit is more profitable for the automaker than any of its regions outside of North America, and it was responsible for billions in losses during the Great Recession. In fact, Ford Credit's operating income plunged from $1.9 billion in 2006 to $1.2 billion in 2007 before swinging to a staggering $2.5 billion loss in 2008.
While GM is billing the conference call as an "ongoing series," the stage seems to be set for General Motors to warn investors about something. Perhaps it's an unexpected snag amid its sale of European operations, a more drastic drop in used-car prices than expected that is pressuring profits in GMF, significant increases in costs to develop autonomous vehicle technology, or higher incentives and inventory than desired.
We'll have to see how this plays out on Monday, but investors would be wise to keep the long term in mind. Even if GM warns about its upcoming quarter, the automaker is still making smart strategic decisions to better position itself over the next decade.