Reflecting heightened concerns about the profit potential of General Motors' (GM ) core North American automotive business, on Mar. 16 Standard & Poor's Ratings Services revised its debt-ratings outlook on the auto maker -- as well as its GMAC financing unit -- from stable to negative. S&P affirmed its BBB- long-term and A-3 short-term ratings on General Motors, GMAC, and all related entities in the wake of its dramatically revised earnings and cash flow guidance. Consolidated debt outstanding totaled $301 billion at Dec. 31, 2004.
On Mar. 16, GM disclosed that it expects to generate a large net loss in the first quarter (even excluding such special items as a restructuring charge related to its ailing European operations), compared with previous guidance of break-even results. Also, the carmaker now expects full-year 2005 earnings per share of $1 to $2 compared with previous guidance of $4 to $5. Moreover, GM's automotive operations are now expected to generate a substantial cash deficit (after capital expenditures, before pension and other benefit contributions and dividends received from GMAC), instead of contributing the previously targeted $2 billion surplus.
We at S&P now view GM's rating as tenuous. The rating could drop at any point if we come to doubt that GM is on a trajectory toward improving its financial performance to more satisfactory levels in 2006 and beyond. If lowered, GM's credit standing would classify as below investment grade.
U.S. light-vehicle sales have fallen off only slightly this year to-date (down 3.6% in January-February from the same period a year earlier), and industry sales remain relatively robust. Yet GM's sales performance in the U.S. has eroded significantly. Its domestic light-vehicle unit sales during January-February were off 9.9% from the same period in 2004. Consequently, its U.S. market share reached a record low of 24.4% in February, necessitating substantial production cuts.
This year represents a hiatus for GM in its product-renewal cycle. But confidence that its performance will improve due to the eventual introduction of new vehicles diminishes because sales of major newly introduced products have generally not met expectations. Of greater consequence for profitability, GM has experienced marked sales weakness across its midsize and large sport-utility vehicles (SUVs), despite significantly increased incentives. These products previously had contributed highly disproportionately to GM's earnings.
However, industrywide demand for SUVs has evidently stalled, partially because of persistent high gasoline prices. In addition, competition has intensified due to a proliferation of new SUVs. GM has suffered from the aging of its SUV product line, which it will replace with a family of new products during 2006 and 2007, but it's questionable whether these will generate the profit margins GM has enjoyed historically.
GM's automotive operations outside North America, and its finance operations -- conducted through GMAC -- continue to meet or exceed earnings expectations, but not sufficiently to offset GM's disappointing performance in North America.
Unless the cash-generating ability of GM's automotive operations improves, its postretirement benefits obligations could grow onerous. Owing to favorable investment portfolio returns, we estimate that GM managed to reduce its worldwide unfunded pension level to a relatively small amount at yearend 2004, compared with an $8.6 billion deficit at yearend 2003 -- even with the adverse measurement effect of a downward revision of the discount rate. (These net liability figures do not include $13.5 billion of debt issued in 2003 to finance pension contributions.)
However, even with $9 billion of VEBA (a health reimbursement account) contributions during 2004, favorable investment portfolio returns, and the estimated $4 billion benefit of the new Medicare prescription drug program, GM's U.S. unfunded retiree medical liability ($53.8 billion at yearend 2004) barely declined from the massive level ($54.5 billion) at yearend 2003.The reason: the effect on the liability of an upward revision of the assumed near-term health-care-cost trend rate -- in light of recent adverse experience -- and a downward revision of the discount rate.
GM's short-term rating is A-3, as is GMAC's. GM's fundamental challenges are short- and long-term in nature. However, GM's liquidity and financial flexibility minimize any potential for near-term financial stress. We believe GM's negative automotive cash flow in 2005 will be offset by the cash flow generated from the GMAC operations. Hence, overall liquidity won't suffer because of the current poor financial performance. But the rapid erosion in GM's near-term performance prospects highlights its high operating leverage and the relative lack of near-term earnings and cash flow visibility.
Outlook: S&P now views the rating as tenuous. The rating can tolerate several quarters of weak profitability and cash flow, but only under the assumption that financial performance improves to more satisfactory levels thereafter. The rating could drop at any point if we come to doubt that GM is on a trajectory to realizing such improvement. In keeping with our policies, the rating would not necessarily be placed on CreditWatch prior to a downgrade.
From Standard & Poor's Ratings Services