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A must-know investor's guide to General Motors Company (GM)

Part 10
A must-know investor's guide to General Motors Company (GM) (Part 10 of 11)

Investing in General Motors (GM): Don’t fear the recall

GM’s response to the recalls

The headlines and news buzz of 7 million recalls, including 2.6 million recalls for ignition switches and cylinders and 13 claimed deaths and lawsuits, precipitated a 15% decline in GM’s share price—from 37.7 on March 7 to April 11’s 31.9. It closed the night of May 8 at 34.75. In rough math, $9 billion was erased from GM’s market capitalization. With nearly two months past us from the initial announcements, is this enough?

GM recall slideEnlarge Graph

Toyota disclosed warranty liabilities of approximately $10 billion at TM’s fiscal year end 2013. This was before the $1.2 billion settlement with the U.S. government. GM took a $1.3 billion charge to earnings in the first quarter 2014. This was for the repair of the then-announced recalls. As GM announced further recalls following the quarter end and it didn’t account for the legal liability, the charge will increase. However, the $15 billion reduction in market capitalization would seem to provide plenty of buffer for the final recall expense.

There’s an interesting issue of liability. Mary Barr got lampooned on Saturday Night Live for “Old GM” and “New GM,” but it’s a real distinction. In bankruptcy court, companies are able to leave their liabilities behind. Debt and other liabilities are restructured in court. The liabilities and warranty costs associated with the recall weren’t all on New GM. The technical distinction gets lost in the reporting. GM could claim the warranty costs isn’t the company’s. This tack would risk further tarnishing GM’s corporate reputation and governmental bodies.

There’s a real financial aspect to this issue beyond the cost to fix and compensate the families of the dead. It’s the residual values of GM vehicles. Resale values of used U.S. vehicles are an issue in financing or purchasing vehicles. A higher residual value provides lower costs to consumers. This metric is increasingly available to consumers and is behind the financing operations. Lower residual values increase the cost of the vehicle to GM Finance and hence to the consumer.

For all these reasons, GM ticked all the boxes on damage mitigation. It hired a former U.S. attorney to investigate, Kenneth Feinberg, created a new VP of safety, created a new program for employees to “Speak up for Safety,” and required all engineers to be Six Sigma black belts by the end of 2015.

New GM management has done all it can do. Now investors have to wait for the cost. The numbers will be large, but the market appears to have already discounted this in. Other manufacturers—including Toyota (TM), Ford (F), Volkswagen (VOW), and BMW Group (BMW)—have also posted recalls in the recent past. You could view this as a buying opportunity and invest in the industry through the exchange-traded fund CARZ.

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