GM's U.S. Blues

The automaker enjoyed a solid second quarter, but it still needs to win over U.S. unions and win back U.S. buyers

by David Welch

For the second week in a row, a U.S. auto company announced a profitable second quarter. Just a week after Ford (F) surprised Wall Street with a profit for the second quarter, rival General Motors (GM) doubled investor expectations with an $891 million profit. But there are continuing warning signs that Detroit has a lot of work to do.

Still, the surprise profits from both Detroit automakers are positive signs that more than two years of ongoing restructuring is starting to take hold. GM not only beat the Street's forecast but its results are a big turnaround from the $3.4 billion loss from the same quarter a year ago. And without $520 million in one-time charges, including $374 million to help restructure its former parts unit, the bankrupt Delphi, GM says it would have made $1.4 billion.

Price-Chopping and Union Wrangling

GM's results are an important incremental step on what looks like a long road to a full recovery. GM lost $39 million in North America in the quarter, but without some one-time charges the carmaker would have made $78 million at home. That means its largest business (which accounts for 63% of revenue) is running at about the break-even point. Says GM Vice-Chairman and Chief Financial Officer Frederick "Fritz" Henderson, "We have to continue to focus on revenue and costs, particularly in North America."

While its overseas operations are improving, sales are still falling at home. GM's North American market share fell from 23.8% to 22.6% and revenue dropped $1.3 billion, to $29.6 billion.

Plus, GM is spending more money to keep sales of its Chevrolet Silverado and GMC Sierra large pickup trucks up (see BusinessWeek.com, 1/23/07, "Chevy's Silverado Lining"). The automaker is offering 0% financing on the trucks, which it relies on for big profits. GM has a lot of pickups on dealer lots, Lehman Brothers (LEH) analyst Brian Johnson said in a report, so higher incentives or lower production could hurt profits later on. "We remain concerned that there may be some payback in the second half," Johnson wrote.

Some other consumer come-ons are costing GM more money as well. GM said adding to its warranty cost reserve funds hit profits to the tune of $500 million. That hit to the bottom line came in part from rising warranty costs and a 10-year, 100,000-mile, engine and transmission warranty that GM started offering car buyers last year.

Health-care costs also remain a big issue. Retiree benefits cost GM $500 million in the second quarter and $1 billion so far this year. The company hopes to wring big concessions on benefits from the United Auto Workers this summer. The company may even try to give the union a big bundle of cash—analysts estimate it to be at least 60% of GM's $60 billion long-term liability—in exchange for getting the UAW to manage its members' health-care benefits.

Cash Flow: More In, More Out

On the upside, GM's profits helped the company generate cash in the quarter. The company has been burning cash for the past few years as it restructures its sprawling network of factories and buys out workers. But in the second quarter, GM actually generated $1.1 billion in cash.