GM Faces Reality

By: Chad Hudson | Thu, Mar 17, 2005
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The government reported that retail sales in February increased 0.5%. This was slightly worse than the 0.6% growth economists expected, but January was revised to an increase of 0.3% from a initial 0.3% decline. Excluding autos, sales advanced 0.4%, again lower than estimates, but January was revised to 1.0% growth from 0.6% initially. Retail sales excluding autos was up 8.4% from a year ago, which was the sixth consecutive month of 8% growth or better, and the twelfth since the beginning of 2004. These sales numbers confirm the strong same store sales growth that retailers reported for February. It also appears that sales momentum has continued into March. This was the third consecutive week where the year-over-year growth in chain store sales was better than 3.3% according to the ICSC. Last week, Wal-Mart announced this week that its March same store sales would exceed the 4.1% gain it posted in February. Target followed up this week saying that its same store sales increase were within its plan of 6% to 8%.

Housing starts increased again in February to a new 21-year high. Additionally January starts were revised higher. The number of permits dropped from January, but remain within 3% of the more than thirty-year high reached last month. With these strong results its little surprise that homebuilders continued to be an optimistic group. The National Association of Home Builders/Wells Fargo Housing Market Index was 69, unchanged from the previous month. The survey also showed that the West had the highest traffic of prospective buyers, while the Midwest was the lowest. This is consistent with the commentary from the builders and other anecdotal evidence.

The rebound in industrial production continued in February, increasing 0.3% from the prior month. While this was 0.1% lower than economists' estimates, January's increase was revised up 0.1% from the initial report of flat. On a year-over-year basis, production increased by 3.5%. This was actually the slowest year-over-year increase since last March. Growth should slow over the next few months since production increased more than 3.8% in each month starting in March 2004 until last month. Additionally, capacity utilization inched higher in February to 79.4%.

There have been several surveys lately that have indicated that companies are more apt to add workers. The Manpower Employment Outlook Survey added to that list this week. Its index increased for the first time in three quarters. It was also the highest level since 2001. Construction jumped. Finance jumped to the highest level in almost 25 years. Mining highest since the early 1980s.

Companies have pre-announced weaker earnings for the first quarter at a higher rate than the previous several quarters. Almost all of these pre-announcements happened during the release of fourth quarter earnings. Even with the higher number of negative pre-announcements, overall earnings growth for the S&P 500 has only declined slightly to 7.3%, as of last Friday. While the overall growth rate for the S&P 500, two sectors have experienced significant changes. Earnings growth estimates for the consumer discretionary sector have declined from 5% to -7%. Offsetting this decline is an upward revision for energy sector to 34% from 17%.

It's likely that earnings growth for consumer discretionary will again be revised downward. On Wednesday, General Motors lowered its guidance for the first quarter and for the full year. Instead of breaking even for the first quarter, the company now expects to lose $1.50 per share. This will be the worst quarterly loss since 1992. For the full year, GM now expects to earn $1 to $2 per share, about half the $4 to $5 per share the company previously guided. Additionally, the company now expects cash flow for 2005 to be negative $2 billion, a $4 billion swing from the $2 billion it expected to make. The company expects to be able to maintain the dividend, which at $0.50 per share per quarter provides some support for the stock price. But investors increased their skepticism after GM's announcement. According to an options trader I spoke with today, the options market is pricing in a 31% cut in the dividend in 2007, up from a 25% reduction that was priced in the priced in on Tuesday.

GM's bond spreads jumped to the highest level since 2001. Investors pushed the spread between GM's 6.875% note due in 2011 and Treasuries by 60 basis points to 385 according to a story from Bloomberg. Standard and Poor's lowered its outlook to negative, a move that might foreshadow a cut to junk status. Standard and Poor's said "We now view the rating as tenuous....The rating could be lowered at any point if we come to doubt that GM was on a trajectory to improving its financial performance to more satisfactory levels in 2006 and beyond." Moody's also said it may cut its rating. It said the company may have to do a "material restructuring" in order to reduce capacity and lower its costs. On the conference call management didn't endorse the need to reduce capacity, it feels it must drive the topline. GM's huge amount of fixed costs makes it difficult to turn the ship around. Plus, healthcare costs are expected to increase.

Investors are hoping that GM's lunch of its new truck models will turnaround sagging demand. This launch is not until the first quarter of 2006, but more importantly, the Japanese automakers have invaded the large truck market and has effectively taken market share. Last week, Edmunds.com hosted a conference call discussing the automotive market. It said that 44% of users that are researching Honda's new truck, Ridgeline, only look at it and do not research other vehicles. Edmunds also said that incentives on Pontiac's new G6 have jumped from $1,291 when it was launched to $3,665 just four months later. GM's market share has dropped below 25% this year. Excluding 1988, when a strike impacted production, the last time GM's market share was this low was 1925.

Economic data continues to point to an expanding economy. Auto sales are definitely one area that is weaker, but this should be expected considering the torrid pace of auto sales over the past four years. Additionally, total auto sales have not fallen dramatically, it is mostly confined to GM and Ford. Strong retail sales and an improving labor market will continue to pressure the Federal Reserve to keep raising interest rates.


 

Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis
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