GM Will Get Last Laugh on First Quarter Gambit

GM Will Get Last Laugh on First Quarter Gambit

By Dale Buss May 4, 2011

When General Motors launched an ambitiously contrarian program of new incentives in January when most of the industry was standing still, tut-tutters said that the company was only buying market share that would be pulled ahead and deducted from its own sales later in the first quarter. But when GM announces first-quarter profits on Thursday that are expected to approach $1.75 billion, and represent its fifth straight profitable quarter, its executives will be enjoying a told-you-so on the nay-sayers.

GM sales and profits came in handsomely for the entire period as they benefited hugely in March from fast-rising demand for GM’s most fuel-efficient vehicles – and because of the nascent problems that beset  Japanese competitors in supplying their own small cars. And burgeoning sales across its car and CUV offerings have more than offset the more tenuous standing of GM’s relatively fuel-inefficient pickup trucks and SUVs, which traditionally are its biggest profit contributors.

“After all of the concern over GM’s incentive strategy, it appears that the favorable profit contribution from higher volumes more than offset the additional cost from the incentives,” Chris Ceraso, automotive analyst for Credit Suisse Group AG, wrote in a recent research note. Jeremy Anwyl, CEO of Edmunds.com, observed that GM’s strategy “seemed to work out well. Because other automakers failed to respond in kind, GM’s incentives created a short-term boost in sales that at least partially offset the increased costs.”

Less Generosity
And GM’s second quarter, already underway, might prove even better. GM yesterday posted a 26-percent sales increase for April, led by the hot-selling new Chevrolet Cruze compact and the fuel-efficient Chevrolet Equinox CUV, even while GM’s incentive spending dropped by more than 10 percent in the month compared with March -- even below what the company said was the industry average as a percentage of transaction prices.

According to Edmunds.com’s proprietary True Cost of Incentives formula, GM’s incentive spending in April – while still by far the highest of any major automaker – declined to $3,016 from $3,259 in March and from $3,301 a year earlier. “In absolute dollar terms, GM’s incentives are still very high,” said David Whiston, automotive analyst for Morningstar. “But as a percent of average transaction prices, they have done well.”

Jessica Caldwell, head of U.S. industry analysis for Edmunds.com, added:  “GM has already dropped incentive spending below $1,000 a car for some models. And the inventory crunch and busy summer selling season are still ahead of us.” Indeed, GM is better positioned than ever in its history to sell small cars – at exactly the moment that small-car demand may reach historical peaks, and when GM will be one of few companies in the U.S. market able to supply these vehicles.

Last month, GM already sold 25,160 Cruzes, nearly double the number of the vehicle it replaced in Chevrolet’s lineup, Cobalt, a year earlier. Moreover, each Cruz tends to be much more highly contented than Cobalts were, said Don Johnson, GM’s U.S. sales vice president, on a conference call on Tuesday. And with an average transaction price of around $19,000, indicating heavy content levels for a small car, Cruze maintains a typical premium of about $2,000 compared with the prices of Japanese competitors such as Toyota Corolla and Honda Civic, he said.

One-Time Thing
GM’s incentives in January and February were nearly 50 percent higher than the industry average, rising to more than $3,711 in Edmunds’ True Cost of Incentives measure. And at the time there were widespread worries that company executives were almost irresponsibly relying on incentives to attract sales, maybe even setting off a “price war,” as Hyundai’s U.S. chief, John Krafcik, put it. Competitors fretted that GM might be trying to return to the discredited business model of overproducing and then overincentivizing to move the metal.

But while not fully explaining their rationale, GM executives insisted that it was a short-term maneuver. Outsiders believed GM might have been motivated by a perceived need to bolster their four remaining brands and to keep as many customers of its now-defunct brands in the corporate stable as possible. That’s why GM incentives focused on existing GM owners and on boosting lease penetration.

Among other successes stemming in part from the January initiative is that GM is succeeding in raising its lease penetration significantly after all but getting out of the leasing business during the depths of the Great Recession. “GM has broadened its market by offering enticing leasing deals, and the strategy has been effective,” said Ivan Drury, an Edmunds.com analyst. GM leasing incentives were up by 45 percent year over year in the first quarter, and in the same time period the percentages of new GM vehicles leased climbed from 11 percent to 21 percent of all new GM vehicles sold, he said.

Pretty much across the board, GM’s subsequent actions and results have redeemed its first-quarter incentive blitzkrieg in the eyes of observers. “They probably did pull sales into the first two months of the year” from later, Whiston said. “But given how much further sales have to rise before they’re back to ‘normal’ levels, I’m not concerned that GM is going to fall back into old habits of putting too much in incentives on the hood and hurting residual values.”

Investment Opinion
Whiston also noted that GM executives have indicated a more sober approach to incentives was their long-term plan even before recent developments with gasoline prices and the earthquake and tsunami in Japan. “Their goal is to be roughly in line with the industry average with incentives as a percent of transaction prices,” he said. “Certainly the raw dollar amount of their incentives isn’t going to go down to the Toyota or Honda level, and obviously in the short term there is no need to add to incentives. But overall it’s still a very different industry now: GM and Ford don’t have to overproduce to sell vehicles and then put cash on the hood to move the metal.”

At the same time, GM’s financial report on Thursday results will be aimed at another constituency: shareholders, the investment community, and the U.S. government. Taxpayers own one-third of GM’s shares even after the “new” company’s initial public offering of stock last fall, and the stake remains something of a hot potato for the Obama administration, in part because so many Americans remain opposed to its de facto control over and responsibility for the automaker. “The government is probably going to lose money on its investment in GM no matter what happens,” Whiston said. “They want to minimize their losses when they do sell, but they don’t want to be holding [the remaining GM stake] at the height of re-election season next year.”

The problem is that, so far, GM’s stock price hasn’t cooperated with the Obama administration in this regard. The IPO price was $33 a share, but the stock mainly has lagged since then because investors have been inhibited by factors including rising gasoline prices, the recent departure of short-tenured CFO Chris Liddell, and questions about the fate of the government’s vestigial stake.

In trading on the New York Stock Exchange on Wednesday, GM closed at a price of $33.04, up 5 cents for the day – and above $33 a share for the first time since March 3. Still, “It could take several quarters of strong GM profitability before the market fully rewards GM,” Whiston said – and, thus, before the U.S. government might want to shed its stake. Most securities analysts who follow GM believe GM can reach a target price of around the upper $40s a share in coming months. In the meantime, Whiston said, the Obama administration is just likely to hold.

Dale Buss:  is a frequent contributor to AutoObserver.com.