Why GM Might Slow Down


By David Welch Few doubt that General Motors is America's strongest domestic auto maker. Among the Big Three, its plants are the most efficient, its cars have the best quality, and it's the only one that has been reporting solid profits in recent quarters. And unlike Ford Motor (F) and DaimlerChrysler (DCX), GM (GM) has maintained its market share. But being the best of a trio of troubled companies doesn't necessarily make GM all that great.

Its most vexing problem right now is weak profitability in its car business. Diminishing profits in its all-important North American auto market is a big reason why GM's stock has been stuck in the low-$40 range since late August. Despite relatively strong sales in North America, price wars have wiped out margins. In Europe, GM hasn't found a way to break even. Only its operations in China and its GMAC finance arm have contributed pleasant surprises to the bottom line in 2003. Indeed, GMAC makes up about 95% of GM's $2.3 billion in operating profits so far this year.

Can GM boost profits in 2004? Its chief market analyst Paul Ballew expects the economy to improve and hike industry sales to more than 17 million vehicles, up from about 16.5 million this year. And GM is betting on new models and cost-cutting to maintain profitability.

REASONS FOR CAUTION. For earnings to start growing again, several pieces must fall into place. GM needs the U.S. economy to rebound enough to boost sales with lower incentives. Second, GMAC must continue to be a cash cow -- which seems unlikely. And most of all, GM's 2004 new-car blitz must turn out some hits.

Those cars have to sell without huge rebates. GM's addiction to incentives to sell the majority of its cars has made some investors wary. "I don't see the stock doubling next year, but Wall Street is [too] pessimistic on it," says Burnham Securities analyst David Healy. "The stock is probably a little undervalued."

Investors have good reason to be wary. GM executives had hoped see the economy rebound more than it has since hitting the skids after September 11. Even though the U.S. is now in recovery mode, GM has been unable to pull back on rebates and recoup any kind of pricing power. Its automotive business globally earned a paltry $34 million last quarter -- albeit a traditionally weak quarter -- on $35.8 billion in revenue.

In North America, GM earned $759 million in the first nine months, down from $2.4 billion in the first three quarters of 2002. It should hit its overall target of $2.9 billion this year, but analysts expect profits to fall slightly next year.

"BORROWED FROM THE FUTURE." GM can probably forget about being able to dispense with buyer incentives next year. Diane Swonk, Bank One's deputy chief economist, says domestic carmakers have simply pulled in too many buyers with incentives over the past two years, so fewer people are looking for new cars in 2004. To keep sales up, GM will need to keep spending. GM has "borrowed from the future," Swonk says, adding that it "will continue to have incentives and weak margins."

GM is betting that some of its new cars will help bring pricing back. Some of next year's models -- such as the Cadillac STS luxury sedan, Pontiac G6 midsize, and Chevrolet Equinox SUV -- look strong. The STS finally gives GM a rear-wheel-drive sports-luxury sedan to rival BMW's 5 Series and Mercedes-Benz E-class.

GM's G6, which replaces the Grand Am, brings sporty styling to the midsize segment. The G6 will be the first of several cars engineered and designed with heavy influence from Robert Lutz, GM's high-profile vice-chairman for product development. And the Equinox is a sharply styled car-based SUV that gives GM a entry in an emerging market where it has been rather weak. Those vehicles could help the bottom line.

LOAN LOWDOWN. Still, other new models may not have the impact GM needs. Chevrolet is now launching its Malibu family sedan. Critics say it drives well but rate its interior craftsmanship as not being up to par with Toyota's (TM) Camry and Honda's (HMC) Accord, which together dominate the segment.

Plus, many of GM's new vehicles -- like the Chevrolet Colorado midsize pickup -- simply replace older models, notes Rebecca Lindland, senior analyst with Boston-based Global Insight. Sales and profits in small pickups have been dwindling for several years. With few models adding incremental volume, and GM's SUVs and pickups getting older, it could lose share, she says. Burnham's Healy says GM will probably hold market share. So, don't expect big gains.

That leaves GMAC to bring home most of the bacon, as it has all year. The trouble: The mortgage-refinancing boom has waned, and home sales are also slowing down. About half of GMAC's profits came from its residential-mortgage business. Low interest rates will help car sales -- and hence, GMAC's auto-loan volume. But overall, that won't keep the lending unit's profits at current levels. "The mortgage business will be down," says Deutsche Bank analyst Rod Lache. "We see deterioration at GMAC."

PENSION BITE. Add it all up, and GM's earnings and stock price don't seem likely to spike any time soon. "We don't see the stock moving up," says Lache, "that's why we have it on a sell." One dissenter, Prudential Securities analyst Michael Bruynesteyn, says GM has more new products coming next year than many competitors. Watch those cars. If they sell, GM could beat the Street's expectations -- and profits could pick up.

GM will also keep taking a hit from pension costs. It raised $13.5 billion in the debt market to pay off its huge pension-fund shortfall, which was $18 billion at the start of 2003. John Devine, GM's vice-chairman and chief financial officer, says the pension plan should be within $7 billion of being fully funded this year in January.

As a result, GM's pension expense will not be as costly as the $3 billion bottom-line hit it caused this year, but the carmaker still says it could have huge pension expenses next year. Without an economic boom or some big hits from its new cars, GM's earnings and stock price will continue slogging along. Welch covers the auto industry for BusinessWeek in the Detroit bureau


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