GM's U.S. Blues

The auto giant announced its first quarterly profit since 2004, but the company is still losing money in its biggest market, North America

The world's biggest carmaker is struggling in the world's biggest car market. Despite only its second quarterly profit in two years, General Motors (GM) is seeing sales continue to drop in the U.S.

For most of 2006, the company's home operations lost money and market share, only breaking even in the fourth quarter. GM relies heavily on its GMAC finance arm for profits, but the lender's contribution will decline. And getting its cash flow headed in the right direction is proving elusive.

"We still have a lot of challenges in the business," said company Vice-Chairman and Chief Financial Officer Frederick "Fritz" Henderson in a conference call with Wall Street analysts and the media. "While improving, we still lost money in North America."

Home Not So Sweet

That still remains GM's biggest trouble spot. Even after taking out $6.8 billion in costs last year, GM-North America lost $779 million and just about broke even in the fourth quarter.

Still, it's clear that General Motors is making progress in its two-year-old efforts to stage a turnaround, especially after having reported a $2.2 billion operating profit for last year and a fourth-quarter profit of $950 million. But digging a bit deeper, it's obvious that GM has plenty of problems left to solve.

GM still lost money last year on a net basis. Restructuring costs and a slew of other one-time charges more than erased the operating profit and resulted in a $2 billion loss.

Some Good News

Where does that put the company? Chairman and Chief Executive Officer G. Richard Wagoner Jr.'s restructuring has GM on more solid footing. The challenge now is taking GM's turnaround to the next level. The good news is that Wagoner knows this. GM just finished taking out $9 billion in costs but another big round is coming, and this summer's labor talks with the United Auto Workers union will play a big part.

GM has some new vehicles that are selling well. Its Saturn Outlook, GMC Acadia, Chevrolet Silverado, and GMC Sierra full-sized pickups are all moving pretty well. The Saturn Aura sedan has also been well received by automotive critics.

But sales at home keep falling. Revenue dropped $1.2 billion in North America in the fourth quarter to $26.6 billion with market share down from 23.6% to 23.2% in the quarter. U.S. sales are down 6% through February of this year.

Feeling the Subprime Pinch

And while there are clear signs of improvements, analysts noted that GM missed expectations. Wall Street's consensus had GM making $672 million in the fourth quarter, but the company disappointed with a $180 million operating profit.

The shortfall came from GMAC. Like many lenders, GM's finance arm took a big hit from the fall-off in the housing market and losses from subprime mortgage loans. Its earnings dropped almost $700 million to $2 billion.

GMAC Chief Financial Officer Sanjiv Khattri said on Mar. 12 that GMAC has moved to reduce its exposure to subprime loans. He said new underwriting standards will push up the credit quality of new borrowers going forward. But the housing slump will continue to hurt mortgage profits.

Smaller GMAC Piece

Plus, GM completed the sale of 51% of GMAC to a consortium led by Cerberus Capital Management on Nov. 30 of last year. So the profits that once brought GM more than $2.5 billion in income some years will now be split.

GM can't count on quite as large a dividend from GMAC as it used to, either. In fact, GM has to pay a $1 billion dividend back to GMAC because of the problems that showed up in the mortgage portfolio last quarter. It was a nice check to assuage any buyer's remorse on the part of GMAC's new controlling owners.

While GM still burned through $3.8 billion in cash last year, the automaker had positive cash flow of $300 million in the quarter. Still, in addition to the cash burn, GM had to peel out $4 billion last year from a fund specially marked for health-care costs. Even with the improvements, Henderson says cash flow will be improved but negative this year.

Product Offensive

That puts more pressure on Wagoner to fix the auto business. There are some good signs.

Getting North America to break even puts the home business on a path toward making money at home this year. In Europe, GM made $227 million, its first profit in seven years.

To keep its product offensive going, GM will increase its capital expenditures from $7.5 billion last year to $8.5 billion to $9 billion this year. Says Henderson: "We think we have some impressive models coming."

Still, more cuts are needed. GM paid almost $5 billion in heath-care payments last year. Those big obligations, plus continued pressure on pricing and margins, make GM's profitability "insufficient for long-term viability given the economic and product cycles inherent in the industry," Fitch & Co. analyst Mark Oline said in a research note.

GM's $26 billion cash hoard leaves the company plenty of room to remain viable, Oline says. But longer term, it's clear that GM needs to come through on Wagoner's promise of delivering "robust profit."

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