Financial Review

Maybe GM Is Too Damn Stupid To Exist

Financial Review by Sinclair Noe
DOW + 259 = 17,895
SPX + 25 = 2065
NAS + 43 = 4893
10 YR YLD – .01 = 2.10%
OIL – 1.14 = 47.03
Tuesday was one of the worst days for Wall Street in months; today we saw the biggest rally in a month. Go figure. The Dow and the S&P were up nearly 1.5%; the Nasdaq less of a gain as Intel warned that first-quarter sales would be below its previous outlook, given weaker-than-expected demand for business desktop PCs and lower inventory levels in the PC supply chain.
Another day, another central bank jumps on the easing bandwagon.  South Korea joined twenty four countries across the globe by easing monetary policy in 2015. Taking advantage of low inflation, the Bank of Korea cut its base rate by 25 basis points to a record low of 1.75%. South Korea also previously cut its forecast for this year’s economic growth to 3.4% in January from 3.9%, and they are widely expected to lower it again next month as China’s growth continues to slow and much of Europe flounders.

 

The IMF has approved a bigger bailout for Ukraine, giving Kiev immediate access to $5 billion of the $17.5 billion in emergency funding to keep the country afloat. Kiev’s conflict with pro-Russian separatists has put the country’s economy into a tailspin with a plunging currency, the highest interest rates in 15 years and central bank reserves of just $6 billion.

 

The euro fell to less than $1.05 before pulling back to trade higher on the day. The European Central Bank’s launch of a 1.1 trillion euro bond-buying program this week has dented the euro’s appeal by driving yields of many euro zone bonds to all-time lows. Light buying in core European bonds pushed Germany’s 10-year yield to less than 19 basis points and France’s to less than 45 basis points. Meanwhile, aggressive buying of peripheral bonds has both Italy (1.04%) and Spain’s (1.05%) 10-year yield flirting with sub-1.00% prints for the first time ever.

 

After spiking to a 10-month high last month, the number of people applying for unemployment benefits sank below the key 300,000 mark in early March. Initial jobless claims fell by 36,000 to 289,000 in the seven days extending from March 1 to March 7, reversing a sharp uptick last month that was likely triggered by bad weather.

 

Retail sales fell 0.6% last month, following even larger declines in January and December. Part of the problem was bad weather, but that doesn’t tell the whole story. Sales at gasoline stations jumped 1.5% — the first increase since last May, but that increase was offset by weaker sales of autos – down 2.6% on the month. Unadjusted retail sales were up just 1.7% over the past 12 months.

 

Combine the lower retail sales number with today’s report from the Commerce Department showing business inventories are at the highest level in almost 6 years, and it would take 1.35 months to clear the shelves at the current pace. That’s bad news because inventories tie up cash. Cash is supposed to be used to make more cash. Cash on the shelf is cash that isn’t working. Maybe we can blame the slow sales on bad weather. If sales pick up, problem solved; but it doesn’t look like American consumers are in a buying mood. If sales don’t pick up, businesses will need to cut back on purchases while they clear their stock. If enough businesses cut back, the supply chain grinds to a halt and all sorts off bad things result. Here’s how it could play out. We wait a month to see if sales pick up; if not we wait another month for the sales promotions and liquidations; if that doesn’t result in sales, then we could see cost cutting (which is another way of saying job cuts), and that puts us right about June, when the Fed might be looking to raise interest rates.

 

The prices paid for imported goods rose in February for the first time in nine months, largely because oil is no longer in a freefall. The import price index increased a seasonally adjusted 0.4% last month; that follows a 3.1% drop in January. Export prices dipped 0.1 percent in February after falling 1.9 percent in January.

 

General Motors’ approval this week of a new $5 billion buyback plan will likely delay one of its important goals: achieving a top-tier credit rating. Standard & Poor’s and Moody’s analysts say the carmaker’s next upgrade could be delayed due to its new capital allocation plan. The buyback scheme was pushed by an activist investor, Harry Wilson, and even if it doesn’t make the company stronger, it might make the shareholders more money, or not.

 

The intentions of a share repurchase plan are simple: to “return capital to shareholders” by spending money in a way that makes the stock go up and shareholders wealthier as a result. The primary idea is that buying back existing shares decreases the supply of outstanding stock, and gives existing shareholders a bigger piece of the company. Each dollar of earnings is spread among fewer shares, meaning that each share should be more valuable. But stock buybacks aren’t all they’re cracked up to be.

 

For example, ExxonMobil bought back more than $13 billion of its own shares last year. The price of oil went down and ExxonMobil share price dropped about 9% in 2014. Another example is IBM; they bought back more than $13 billion of its own shares last year and the share price underperformed the broader S&P 500 index by about 25%. Not much of an advantage. The problem with IBM is that the one-time tech giant isn’t doing anything very innovative, and a buyback scheme can’t cover that flaw.

 

General Motors announced today that, beginning with the 2016 model year, they will cut the warranties coverage on Chevrolet and GMC vehicles. The new warranties will be five years or 60,000-miles on the powertrains, including courtesy transportation and roadside assistance, down from five years or 100,000 miles. Free maintenance will drop to two visits within 24 months, from four.

 

GM issued a statement that said: “We talked to our customers and learned that free scheduled maintenance and warranty coverage do not rank high as a reason to purchase a vehicle among buyers of non-luxury brands. We will reinvest the savings we will realize into other retail programs that our customers have told us they value more than these.”

 

We don’t know what retail programs they intend to reinvest in, but we do know they plan to invest $5 billion into a stock buyback plan. And that goes against the published research on warranty coverage. According to a study published in the Journal of Business Research curtailing warranties is bad for business. The study found that: “Warranty improvements signal improved vehicle quality and lower maintenance costs. Warranty curtailments signal the opposite.” The authors note that “Korean manufacturers’ share of the U.S. market quintupled from 1%
in 1996 to 5% in 2006. Much of the credit for this increase has been attributed to restyling, lengthened warranty, and improved quality.” And cutting warranties results in a 24% decline in market share growth.

 

The study finds that if you want to sell more cars, restyling gives you the biggest bang for the buck. In other words, build a better car, give it a strong warranty so people know you are confident that it is indeed a better car, and people are more likely to buy it. Sounds like common sense.

 

Now, keep in mind that GM is still dealing with claims of defective ignition switches that resulted in crashes that killed 64 people and 1571 other claims are in for injuries. The executives at GM knew for 13 years that their cars had a defective ignition switch that would, well, kill people. But they did a “cost-benefit analysis” and concluded that paying off the deceased’s relatives was going to be cheaper than having to install a $10 part per car. They then covered up their findings and continued to let millions drive around with the defective part in their cars.

 

So, in the real world, GM must now deal with the death and injury claims; they could repair all the defective switches so nobody else dies; they could make sure there are no additional killer design flaws; they could invest in R&D to build a better car, a car that looks great, runs more efficiently, is safer for the drivers, and is so reliable that they could increase the warranty with confidence – or – they can kowtow to one activist corporate raider and gamble $5 billion on a stock buyback scheme that may or may not pay off; and in the process, they are destroying their own credit rating and hamstringing liquidity.

 

About 7 years ago GM was on the verge of collapse. Back then we had high oil prices and the Big Three US automakers were stuck making big trucks and SUVs and when oil prices jumped, buyers developed an aversion to gas guzzlers. GM was slow to respond and soon they were bleeding cash. They turned to Uncle Sugar for a bailout, to the tune of $49 billion. GM was essentially nationalized. In December 2013, Treasury sold its last GM shares. According to a tally by the US Treasury, taxpayers lost $9 billion on the U.S. government’s automotive industry rescue program. According to another study by the Center for Automotive Research, a couple of million jobs were saved and the government “saved or avoided the loss of” $105 billion in lost taxes and social service expenses, such as food stamps, unemployment benefits and medical care. Of course there were some vendors that got stiffed by GM in bankruptcy. And it might have been cheaper to just give every GM worker a check for $250,000 and tell them to make the most of it.

 

We could debate whether the bailout was good or bad, but the bottom line is that GM is still around and now they are profitable, at least for Harry Wilson. The bad thing is that they didn’t learn from their struggles. They aren’t setting aside money as a cushion for a rainy day; they aren’t taking the $5 billion for stock buybacks and investing in R&D and innovation and better, safer cars. They didn’t learn any lessons about how to serve their customers, how to treat their employees and vendors, or how to show gratitude for the country that saved their bacon. And so, if GM ever finds itself in the same situation as they were in just 6 short years ago, the debate should not be about whether there should be government intervention or not, we could just look back on their decisions of the past week and we could all agree that GM was too damn stupid to exist.

 

 

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