As fellow Fool Seth Jayson reported, General Motors (NYSE:GM) made good on its promise, losing $1.1 billion in the first quarter of 2005. How did the world's top automaker go from earning $1.3 billion in the first quarter of 2004 to this? Let's take a look at recent events that led to the top automaker's situation.
The announcement that started the cycle
The flood of events got underway back in mid-March. It was then that the company reported that it expected to lose $1.50 per share for the first quarter, compared with an earlier target of breakeven or better. For the year, GM lowered its expectations from $4.00 to $5.00 per share to a range of $1.00 to $2.00 per share. Perhaps even worse was the fact that free cash flow estimates did an about-face, from positive $2 billion to negative $2 billion. Investors reacted in kind, sending the stock down 15% by the end of the week. The stock now trades just above $26.
In response to the bad news, whispers (OK, more like shouts) began circulating that GM's debt rating could possibly be cut to junk. If that happened, those investment funds that are only allowed to hold investment-grade rated paper would have to sell. With nearly $300 billion of debt issued, the impact would be enormous. Standard & Poor's currently rates GM bonds BBB-, which is one level above junk. Think about that. The world's largest automaker and second-largest corporate borrower outside the finance industry is rated just one level above junk.
GM is already in a difficult situation because of its poor rating. Investors in the company's bonds are demanding higher rates to compensate for the increased risk. Higher payments would take away from the company's already declining profits. That would mean less cash to invest in new designs, which GM desperately needs to generate sales in order to improve its credit rating. Got that?
Word then got out that GM was considering selling a majority stake in its commercial mortgage unit, which is part of its GMAC business. The sale has become more likely because of GM's poor credit rating. A 50% stake in the GMAC commercial mortgage unit is valued at about $1 billion, according to The Wall Street Journal. GM maintains that the move is not being made to add to its nearly $23 billion cash horde. Instead, the money would stay within GMAC's business.
The declining performance of GM's automotive business is what's causing the threats of its rating to be dropped to junk. Because investors are losing faith in the company, GM is forced to pay more to lure investors to its bonds. Interest expense at GM and its finance unit rose 26% to $11.9 billion last year. So now GM is trying to compensate by selling off a chunk of its finance unit.
Even though GM would maintain a significant stake in the commercial mortgage unit, giving up the majority of a well-performing unit isn't a good idea in my opinion. I think it's a mistake to give up profits -- both current and future -- to get cash up front to compensate for the shortcomings of the automotive unit, particularly when the move would result in lower profits, which could further damage GM's credit rating.
Phase out or not?
Around the same time that talk of the GMAC mortgage unit sell-off was circulating, word got out that GM was considering the possibility of phasing out its Buick or Pontiac brands, or both. That came as a shock to many, considering GM is in the midst of a $3 billion investment in new vehicles for Buick and Pontiac. As it turns out, GM came back the next day and said it would not be phasing out any of its brands and that words were simply taken out of context.
So if it's not going to happen, why mention it? I mentioned it because I think it should happen. GM has too many brands to design, improve, and market. If Buick or Pontiac were phased out tomorrow, would many people really care? Or even notice? I wouldn't, at least.
Lots of news and work to do
That's a lot of information, and I haven't even mentioned issues GM is having with the United Auto Workers union, or that it just replaced its chief of China operations after the previous chief stepped down for personal reasons fewer than five years into the job, or its CEO taking over its North American division. So, what can it do to survive and maybe even keep defending its top spot?
It's actually fairly simple
Even with the plethora of issues GM must overcome, I do believe it can get things turned around if it simply changes its thinking.
First, GM has to realize the competitive market in which it is competing. Its days of controlling 40% of the market are gone forever. There are simply too many players in the market to allow one company to maintain such a large share. GM must find a way to remain profitable with about 20% market share.
To make the first step more plausible, GM should reduce its vehicle lineup. I hit on this above, so I won't repeat it here.
Next, GM must get away from its self-set incentive trap. It seems as if there are new rebates and low financing offers every month on most of its lineup. Now, I know every car manufacturer offers special deals to clear off its lots. But in March? For the new models? And I'm not talking about 3.9% financing or $1,000 cash back. In its recent March Madness promotion, GM offered 0% financing plus up to $1,500 cash back, or up to $4,500 in total cash allowances, on what seems to be most of its lineup. That's $4,500 on the 2005 models and it's only April.
I can't imagine anyone paying full price for anything other than the company's brand new models. This gives the impression that its vehicles aren't as valuable as the competition, as the company continually offers deep discounts on a good part of its lineup. More appropriately, it might just be the case, as the company hasn't experienced meaningful sales increases for the past three years despite these discounts. In addition to the negative perception this leads to, GM's margins also suffer as a result. It won't be easy, but GM must gradually move away from making these offers.
Now, what I consider to be GM's biggest problem is perhaps its easiest to fix. To put it simply, GM needs to start listening to what consumers want. Currently, GM seems to think it can simply tell people what they want and they'll buy it. Obviously, that's not the case.
GM continues to focus on producing large SUVs and pickups in spite of higher gas prices. The company plans to introduce an all-new lineup of full-size SUVs and pickups for 2006. GM has obviously benefited from the high margins provided by SUVs and pickups, but with high fuel prices seemingly here for the foreseeable future, the public is shifting toward more fuel-efficient vehicles. Which leads me to...
Where's the hybrid vehicle? How can the world's top automaker not have one true hybrid in its lineup? All GM offers is a hybrid version of its Chevy Silverado and GMC Sierra 1500 large trucks, which, by the way, are really the same truck. But that's it. Where's its one true hybrid vehicle? I realize the margins aren't as high as those of SUVs, but that's not the point in this case. It's about giving customers what they want and proving the technological capabilities of the company. I realize GM is working on fuel-cell technology, but that could be 10 or more years away. Meanwhile, Honda (NYSE:HMC) and Toyota (NYSE:TM) can't seem to keep hybrids on the lots.
GM has a lot of work ahead, and things may get a bit worse before they start to get better. Toyota will probably take over as the world's top automaker in the next few years -- it's predicted to happen in 2008 -- and GM's sales will likely continue through rough times for now. However, GM can't worry about those things. It must concentrate on the business at hand, namely designing and marketing a broad spectrum of vehicles that stand out from the competition and offer consumers what they want. If it can do that, the rest should fall into place.
Fool contributor Mike Cianciolo welcomes feedback and doesn't own any of the companies in this article. The Motley Fool is investors writing for investors.
