Will GM Earnings be Driven by Channel Stuffing?

GM logo and ObamaEarlier this year, I reviewed General Motors’ first quarter earnings report and annual results. My take-away from the report was that GM relied upon shady accounting techniques and a build-up of US dealer inventories to produce some rosy-looking results. Channel stuffing to the tune of an over 20% increase in inventory from year end 2011 provided for GM’s revenue growth. The trend continues as GM has further pumped-up inventory for quarter one.

The reason that dealer inventory figures are so important is that automakers record revenue when vehicles are shipped to dealerships, not when they are actually sold to consumers. It becomes fairly easy for a company like GM, which operates more with an eye on perception and politics rather than on sustainable profits (why else would they focus so much on the money-losing Chevy Volt?), to manipulate revenue and earnings by getting vehicles into dealerships’ lots. The first quarter saw another increase of inventory levels to about 744,000 vehicles from around 717,000 at the start of the quarter. This is an almost 4% increase.

GM derives much of its profits from sales of higher-priced trucks and SUVs in North America. It is not surprising that this is the area where GM focuses its inventory build-up. Full-size pickup inventory was at 239,718 at the quarter end. This is a 117 day supply. Ideal inventory levels are considered to be in the 60 day range.

The fact that GM’s inventory build-up is the primary driver of revenue “growth” at the company has been mostly ignored by analysts and the media. Chris Ridder at Seeking Alpha was an exception and did an excellent job spelling out the numbers in a recent piece. This followed an earlier report by Tyler Durden at Zerohedge.com. The Wall Street guys, however, seem to be treating GM with kid gloves on the very important subject. We’ll have to wait to see if the numbers are questioned during GM’s upcoming earnings conference call.

A crucial aspect of GM’s inventory build that has been totally ignored is the fact that it is costing lots of shareholder (and taxpayer) money to stuff dealership inventories. You see, dealerships are not going to borrow money from government-owned Ally Financial (the source for most GM dealership inventory financing) to flood their lots with high-priced trucks just out of the goodness of their hearts. GM has to incentivize dealers to take the inventory. The more vehicles dealerships take, the more incentive kick-backs they receive. In fact, GM will not reimburse dealerships for certain incentives unless they take a predetermined, minimum number of new vehicles for inventory. If dealers do not take the vehicles they will not get the pay-offs.

We will soon see how the numbers shape up for GM in the first quarter. An eye should be kept on how GM is reaching its numbers. Will non-GAAP (Generally Accepted Accounting Principles) figures and special items (such as tax credits) be used as had been done with the last earnings report? How much is inventory build-up contributing to revenue growth as opposed to real sales to consumers?

One thing is for certain, GM will not be able to rely upon smoke and mirrors to hit its numbers indefinitely. At some point the company will have to focus on building quality, mainstream vehicles rather than striving to be a market leader in green vehicles that do not have significant demand. If they do not, billions of taxpayer dollars will have been wasted on a company that will have to revisit bankruptcy court as a result of being the market leader in fudged earnings numbers while allowing others to continue to lead when it comes to building profitable cars.

Mark Modica is an NLPC Associate Fellow.