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GM's Losses Close to Home


The combination of reduced profits at GMAC and weak sales in the North American market led to missed expectations

As if General Motors (GM) didn't have enough to worry about with getting its car business fixed in North America—problems at its GMAC finance business have taken their toll on the company.

In past years, even when GM's auto business brought home stronger profits than it does today, its GMAC finance arm carried the company. Lending profits were sometimes 90% of GM's earnings. But in the first quarter of this year, GM made a scant profit of $62 million in the first quarter thanks to losses from GMAC's subprime loan portfolio. GMAC's troubles chopped $116 million from GM's earnings.

While subprime loan problems won't plague GM's profits forever, the lender's lower profitability just underscores how important it is for GM to start making real money in its auto business. Even if GMAC gets back to making big-time profits, GM will only get 49% of the earnings since it sold 51% of the company to a consortium of investors led by private equity firm Cerberus Capital Management last year.

Pulling Back on Rentals

The bigger problem is that a full recovery in GM's vital North American car business seems a long way off. Sure, GMAC's problems hit GM's results, but the company still missed Wall Street's forecast of $487 million by a long shot. The North American car business was the main culprit.

GM brought in record revenues in the first three months of the year in its global operations, but made just $304 million in its auto business. The North American business dropped revenue and lost $85 million at home. Says Vice-Chairman and Chief Financial Officer Frederick "Fritz" Henderson, "It's good to see improvement but it's not good to still be operating at a small loss."

Despite a flurry of new models in North America, revenue in the market fell 8% to $28.5 billion. Henderson says it's because GM has pulled back on low-margin sales to rental fleets and cut production to help dealers thin their inventory. A weak car market isn't helping, either.

Better Prices for New Vehicles

The biggest cause for concern is that, despite two years of cost cuts and union concessions, GM still isn't making money in North America. Several analysts griped that GM also just launched a flurry of new models and is showing slow progress. Goldman Sachs (GS) analyst Robert Barry said in a research note that, "This seems like a weak performance to us given we are at the peak of GM's product cadence and North American revenue per unit showed significant strength."

There are a few positive signs, though. GM brought in $21,000 per vehicle in revenue, up almost $1,000. Henderson says that's because new vehicles like the Chevrolet Silverado and GMC Sierra pickups, the Saturn Aura family sedan, and the new Saturn Outlook and GMC Acadia crossover sport-utility vehicles have brought in better prices, and customers are ordering them with more expensive options.

If GM can keep making pricing gains, it could help fuel a recovery. Toyota Motor (TM) generally sells its vehicles for $23,000 to $24,000 in average revenue. But GM's brands still struggle to capture the imagination of consumers and get better prices in the market.

Gas Prices and Market Share

Add it up and GM's efforts to bring back robust profits in North America will be a long, tough slog. Cutting production due to weaker sales hurt profits by $1.1 billion in the quarter.

Looking ahead, GM has other problems on its plate. Higher gasoline prices hurt truck sales in April, and Paul Ballew, GM executive director of global market & industry analysis, says that will continue in the second quarter. Morgan Stanley (MS) analyst Jonathan Steinmetz said in a research note that new vehicle launches will slow down in the second half of next year. Increased competition from foreign carmakers like Toyota "will make it tough to stop the loss of market share in the U.S.," Steinmetz wrote.

GM clearly has more cost cutting to do. Labor talks this summer will be a big part of that. GM will try to cut its health-care costs, which total $5 billion a year in cash. The company may also look to slash layoff benefits and staffing levels. GM does have two plants scheduled for closure next year—that could help. "We're not stopping with cost reduction," Henderson says. "There's more to come."

There will have to be. With GMAC becoming a less reliable source of income, GM's car business will have to do more than tread water.

Welch is BusinessWeek's Detroit bureau chief.

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