General Motors has not been a good stock to own so far in 2014, with shares trading down by 10 percent. While some investors might see this weak price action amid bearish news as a contrarian indicator, I suspect that the stock has more downside risk. Here’s why.
First, and most obviously, is the company’s trouble with recalls. The company has recalled millions upon millions of vehicles over the past couple of years. This is extremely costly. It also makes the company look bad, and its products appear to be dangerous. With so much competition in the auto space, I suspect that these recalls are going to hit sales in a big way, with long-term, loyal customers being the only reliable source of demand.
Second, while the company reported higher sales year over year, it is also reporting higher operating expenses, meaning that its operating profits are declining. The company’s costs are rising for several reasons, including high commodity prices, high R&D costs, and high salaries. Regarding this last point, we need to recall that the United Auto Workers union owns a big chunk of General Motors now, and while it is a shareholder, its loyalty isn’t to shareholders but rather to the workers. The result is that GM workers are more likely to be overpaid, and this hurts the value of the company.
Third, if you look at the company’s financials, you see two bearish trends: an increasing debt load and an increasing share count. The former makes the business riskier. It means the risk that the company will not be able to meet its obligations in a credit crunch is gradually increasing. The latter is akin to inflation — more shares outstanding means that each individual share is worth less.
Fourth, and I’ve already touched on this point, is that the automobile industry is extremely competitive. These companies have to spend hundreds of millions of dollars marketing just to maintain market share. They also have to continually improve their models in order to keep up with consumer demands (e.g., fuel efficiency, larger cabins, access to advanced technologies). As investors, we are looking to invest in industries that aren’t competitive, and this makes the auto industry unappealing. By extension, we can say the same about General Motors.
Fifth, while auto sales have been rising in the United States, this is in large part due to extremely loose lending policies of the auto companies and their lending arms. GM and its peers are practically giving their cars away and hoping that the buyers/borrowers eventually pay for the car. This is reminiscent of the auto market (not to mention the housing market) of 2007, and we know from that experience that this works for a little while, but only until it doesn’t.
With retail sales coming in weak over the past few months and with a relatively sharp decline in GDP in the first quarter, odds are that this cycle has reached its peak. Furthermore, if the Federal Reserve continues to taper, that can put upward pressure on interest rates, and fewer consumers will be able to buy cars on credit — or at the very least, they will have to buy less expensive cars.
Ultimately, the automobile industry is highly cyclical, and it seems that we are at or near the peak of the economic boom. While some companies are positioned to weather the coming storm, General Motors has made life difficult for itself with its multiple recalls and damaged image. If we couple this with higher expenses, it follows that GM could be setting itself up for a big tumble.
Disclosure: Ben Kramer-Miller has no position in General Motors.