The GM Death Spiral

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Comments: 0

July 3, 2008

I believe the following Chart 1 says much about the future prospects for General Motors. GM's stock price dropped $1.77/share or 15% from the previous day's trading setting not only another 52 week low but also another 50+ year low. Currently GM's market value is under $6 billion. To put this into perspective, Toyota is valued at just under $160 billion. Even with Ford trading a under $5/share the company is valued at $10 billion.

Shares of GM fell on a Merrill Lynch report downgrading to company from a "buy" rating to"underperform". The report stated,

"We believe that the weakness in demand and deteriorating mix through the first half of 2008 are just the beginning of what is shaping up to be a more severe downturn than even the most bearish industry observers expected."

Merrill Lynch also expects GM's share price may drop to $7 over the next 12 months on concerns that the company may have to raise $15 billion in the next two years. Furthermore, the analyst wrote,

"Bankruptcy is not impossible if the market continues to deteriorate and significant incremental capital is not raised."

This report is consistent with a recent Fitch downgrade of GM's debt and a Business Week analysis of the company's cash position.

Chart 1: 10-year GM Stock Price

Under the leadership of Chairman Rick Wagoner, the company since 2005 has made significant gains in restructuring its North American operations, beginning to build truly high-quality, world class product, a leader in emerging markets however the company just cannot gain traction with the US buyer. Making matters worse has been fuel prices and the greater economic conditions in its home market. It would finally appear that almost 40+ years worth of well-documented problems have finally caught up with General Motors.

I have been reviewing the latest sales results for the US industry (Chart 2) and it is not encouraging. What is most concerning is GM's poor performance that is not apparent from the aggregate totals.

Earlier last month, J.D. Power and Associates was predicting GM's sales would be down 26%. For the month, GM's sales were only 18% below the previous year and consistent with the larger industry. However I believe GM's better than expected showing can be attributed to increased incentives and 0% financing deals that improved its results after J.D.Power conducted its study. In other words, GM's performance the second half of June were not healthy sales as the company had to spend money to move the product (Chart 3). In the short term this could probably improve cash flow but it is certainly not sustainable. The incentive spending is what resulted in the 2005 restructuring effort in the first place. I also suspect the destructive incentives were driven by the company attempting to maintain its number one sales position over Toyota in the US.

The breakdown of the company's June sales, were similar to May 2008; car sales were down again. It still appears buyers did not transition to GM cars from trucks unlike Toyota as its cars sales were only down 1.9% and Honda, which was up 34%. I also find it troubling that GM's Trailblazer SUV sales were up 28% (10,516) for the month and its fullsize SUVs (Tahoe, Yukon) were only down 10%. The question that needs to be asked is: How much money did this cost the company?

On a whole the high profit GMC truck division was down 24%. The GMC Acadia large crossover SUV was down 40%, which may have resulted form a lack of inventory do to strikes earlier in the year. Automotive New was estimating a 43 day supply going into the month of June (10,400 in inventory vs. 4,197 delivered).

In the latest J.D. Power and Associates 2008 Automotive Performance, Execution and Layout Study(APEAL)SM GM brands generally were below the industry average. APEAL examines how gratifying a new vehicle is to own and drive, based on owner evaluations of 10 measures, encompassing more than 90 vehicle attributes. Over the years, vehicle models achieving high APEAL scores have been shown to benefit from faster sales, reduced need for consumer incentives and higher margins on each vehicle sold.

The American automakers as an industry "rightly or wrongly" still have a perception problem with the public. According to another J.D. Power study, 54% of consumers will only consider foreign brand cars. With high profit truck sales down at GM, its car sales confirm the JD Power 's findings when weighed against Toyota and Honda's car sales. The public did not have a problem purchasing a GM truck or SUV however consumer are not as likely to even consider its cars. Given the public is transitioning to cars because of high fuel costs, this can be a serious problem for the company going forward.

My views on GM are not in conflict with either Fitch or Merrill. The overall market is contracting, money making truck and SUV sales will continue to drop and GM is not picking up what buyers remain with its cars. I foresee GM's US market share heading to its global share of around 15%.

With that I am eagerly awaiting to hear what GM has planned later in the month. It better be impressive because as I see it, the situation is dire. For the record I did not buy into many of the arguments that were made circa 2005 and 2006 that bankruptcy was a real possibility for GM. GM at the time had assets to sell which they did. The global stock markets were doing well and the retirement VEBA was well over funded. GM did draw down billions from this VEBA since 2005.

This time, GM does not have the assets to sell to raise cash and a need for a serious capital infusion within the next 12 - 18 months to get the company through this may be necessary. GM was sitting on $24 billion as of the end of the first quarter. However I do expect the strikes, incentives, GMAC to negatively impact its cash position probably worse than expected by some analysts. The second quarter cash decay is just not known yet. GM certainly has options to raise capital, just not good ones. Remember this, GM still needs to begin funding the UAW Health Care VEBA in 2010. Much of that money was to come from the retirement VEBA. Finally, GM is not a debt free company either. According to GM's Annual Report, as of December 31, 2007, the company has $39.4 billion in loans payable and long-term debt outstanding for its automotive operations in addition to funding requirements of more than $30 billion under the 2007 UAW agreement.

June June June 6 mos. 6 mos. Pct.

2008 2007 Change 2008 2007 Change
Aston Martin 140 171 –18.1% 840 171
BMW Group 26,192 29,429 –11.0% 158,135 164,548 –3.9%
Chrysler LLC 117,457 183,347 –35.9% 867,826 1,113,093 –22.0%
Daimler AG 22,142 19,615 12.90% 130,774 118,376 10.50%
Ford/Lincoln/Mercury 166,461 230,782 –27.9% 1,105,027 1,285,442 –14.0%
Aston Martin 856
Jaguar 1,410 7,021 8,461 –17.0%
Land Rover 4,160 14,292 22,842 –37.4%
Volvo 7,001 9,572 –26.9% 46,181 53,808 –14.2%
Ford Motor Co. 173,462 245,924 –29.5% 1,172,521 1,371,409 –14.5%
General Motors 262,329 320,668 –18.2% 1,589,235 1,897,720 –16.3%
American Honda 142,539 140,935 1.10% 798,358 766,929 4.10%
Hyundai Group 78,325 75,656 3.50% 388,685 390,987 –0.6%
Isuzu 364 676 –46.2% 3,339 3,777 –11.6%
Mazda 23,771 25,761 –7.7% 153,141 152,684 0.30%
Mitsubishi 7,494 13,014 –42.4% 53,883 70,357 –23.4%
Nissan 75,848 92,213 –17.7% 522,322 535,379 –2.4%
Porsche 2,650 3,267 –18.9% 15,086 17,859 –15.5%
Subaru 18,007 17,108 5.30% 94,095 90,154 4.40%
Suzuki 9,785 10,325 –5.2% 56,248 57,488 –2.2%
Tata Motor 3,560 3,560
Toyota 193,234 245,739 –21.4% 1,240,085 1,331,074 –6.8%
VW 31,626 31,226 1.30% 162,175 162,847 –0.4%
Other (estimate) 652 624 4.50% 3,987 3,842 3.80%
TOTAL 1,189,577 1,455,698 –18.3% 7,414,295 8,248,694 –10.1%

Chart 2: June US Sales (Source Automotive News)



Chart 3: June Sales Incentives (Source Detroit News)

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