A European crisis for GM

The third quarter earnings for General Motors reflects a change in most variables but an incorrigible consistency in one. It has failed to reverse close to $15 billion in cumulative losses that GM’s European operations have been plagued with since 1999.

Third quarter earnings fell 14% largely arising from record losses in Europe. Vehicle sales in the region dropped significantly with a pre-tax loss of $478 million, from $292 million, a year ago. A large chunk of this loss is making its way into GM through the restructuring of its principal European brand, Opel in Germany. Over the quarter, Opel and its dealers have cut vehicle inventory by more than 100,000 cars, slowed production and improved sales at dealerships, in addition to seeing job cuts of 2300 out of a projected 2600 workers in 2012. The staff reductions are set to continue through 2015.

From the time GM was bailed out by the government, its European business has been on a constant decline. Fixing Opel and returning the division to profitability has been difficult. Despite large-scale cuts, factory closings and efforts to better align production and market share, it has brought no respite to the continuing losses. Shorter workweeks, better inventory management and fewer bottlenecks have however made some headway in reducing costs. The full year losses in Europe spanning across 2012 are in the range of $1.5 billion and $1.8 billion. The region is expected to break-even on an operating basis by mid-decade while sales are expected to fall between 4% and 5%.

GM’s net income fell from $1.73 billion a year ago, to $1.48 billion in the third quarter. In contrast, global revenue increased from $36.7 billion to $37.6 billion this quarter. Pre-tax income went down from 2.19 billion last year to $1.82 billion in the third quarter. Profit for the quarter ended at $1.83 billion or 89 cents/share compared with $2.11 billion or $1.03 a share, a year earlier. The company however, beats analyst’s expectations, making 93 cents/share above expectations of 60 cents and revenue of 2.3% to 37.57 billion, beating expectations of $35.7 billion.

China through Australia, international operations have provided the biggest boost to the quarter. Strong operating profits in Asia and South America gave an impetus to most of the financial hit. Largely powered by Chinese operations, the international divisions earned a pre-tax income of $689 million, compared with $365 million, a year earlier. Operating profit of $689 million compared with $365 million was reported. GM’s China joint ventures contributed $414 million, up from $376 million, a year ago. The South American unit swung to a profit of $114 million compared with a loss of $44 million, a year ago.

GM’s sharply higher cash flow is a welcoming change for investors. Automative cash flow rose from $1.3 billion, a year ago to $3.1 billion. The gain is a result of higher pre-tax income and fewer adjustments for cars coming off as leases.

The plummeting numbers at its European operations have however affected the price of GM shares, which are directly linked to investor patience. Despite replacing Opel’s boss twice since last year, no drastic solution seems to have come through, besides some modest cutbacks and a cost-sharing pact with Peuguet-Citroen.

According to Morgan Stanley, an investment bank, Opel’s losses in the next 12 years could be even higher than those in the past 12. Based on Opel’s continuing cash-burn, and its long-term pension liabilities, the bank’s analysts put a value of minus $17 billion on the European operation, which means that it is reducing GM’s share price by about $10.

“We used to be way behind the others, and it is still bloody out there, but we are getting some wins and we are seeing some green shoots in the mud. This company used to build cars without dealer orders and we aren’t doing that anymore’, says Stephen Girsky, Former Vice Chairman of GM’s Adam Opel European unit articulating the current state of operations at the unit.

Morgan Stanley suggests that GM would be in a better situation if it agrees to lose the European operation. The investment bank argues in favour of Daimler and BMW, for choosing to cut off from Chrysler and Rover, respectively and maintains that both firms benefited from cutting their losses -implicitly suggesting, it is time for General Motors to get rid of its European operations and do the right thing.

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