Recall Expense Not Reason For GM’s Poor Earnings

head in sandGeneral Motors reported lackluster first quarter earnings’ results as the company took a $1.3 billion charge related to recalls. Most of the expenses for the approximately 7 million vehicles recalled, however, were not actually incurred during the first quarter.

In addition, the $1.3 billion figure is far lower than what the recall will cost GM. The power steering recall alone of about 1.5 million vehicles (which was prompted by NLPC’s exposure of the recall delay) is likely to cost more than that. The estimated cost for replacement of power steering columns is in the area of $1,300 per unit, bringing the total for this single recall to roughly $2 billion. That doesn’t include loaner cars.

There will also be legal costs and settlements which are likely to measure in the billions of dollars. Regardless of the extend of what the total costs of GM’s recent recalls will be, the earnings report left little for investors to be optimistic about.

GM’s balance sheet is headed in the wrong direction with cash, cash equivalents and marketable securities falling from approximately $29 billion to about $28 billion over the last three month span. Short and long term debt rose by over $1.5 billion, now at pre-bankruptcy levels of over $37 billion. My assertion that most of the recall expenses were not incurred, as reported, in the first quarter was confirmed during the conference call by GM with the following statement by CFO, Chuck Stevens:

The Q1 cash flow did not include a significant level of cash spend costs associated with the recall….The fundamental cash associated with the recall will start to fall when we’re repairing vehicles. If I look at the cadence it’s going to be weighted Q2 to Q4 pretty evenly for the rest of the year; that’s when the cash costs are going to roll through the results.

The poor earnings results are more likely a result of unimpressive sales rather than recall expenses. GM’s automotive revenue fell year over year from $36.344 billion to $36.315 billion. The overall small revenue increase was attributed to GM’s finance unit. US market share fell as well, from 17.7% to 17%. Worldwide market share fell from 11.3% to 11.1%. Most damaging was the failing truck launch for GM. The most profitable segment of trucks and crossovers saw sales fall from 265,000 during the first quarter of 2013 to the current quarter’s 235,000. Ouch!

Yet another concern was the rising inventory level at dealerships which went from 748,000 at the start of the quarter to a bloated 815,000; over a three month supply. A 60 day supply is considered ideal, but GM records revenue as vehicles go to dealers’ lots so they have motivation to maximize the amount of inventory sitting at dealerships to pad revenue numbers. This eventually hurts the company as incentives need to rise to help sell off the vehicles.

Perhaps the most glaring indicator that GM is being run inefficiently is the operating loss in the automotive segment. GM had an automotive operating loss for the quarter of $756,000,000. This is hidden by the fact that GM had $605,000,000 of equity income and a tax benefit of $303,000,000. GM was able to squeak out a small earnings profit as a result of non-operating income and the financial unit. Even after billions of taxpayer dollars, the car business at GM is losing money.

The tax benefit was a continuing gift from the Obama Administration as the company was granted billions of dollars in tax credits as it emerged from bankruptcy. So much for corporations paying their fair share! It seems that paying a fair share doesn’t apply to Crony Corporations.

The knee-jerk reaction to the earnings report saw GM share price initially rise before heading downward as earnings were digested. The coming quarter is likely to be even worse as recall costs are really incurred and GM continues to struggle making competitive vehicles. Maybe they’ll come up with some new plug-in electric vehicles to distract from the very real problems at GM. If the past is any indication, it won’t help.

Mark Modica is an NLPC Associate Fellow.