GM Hurt by Recalls While Margin Growth Drives Ford Earnings

General Motors (NYSE:GM) reported second-quarter earnings that were heavily impacted by the automaker’s ignition-switch recall, while Ford Motor Co. (NYSE:F) booked profit growth of 6% amid a higher profit margin in North America and strength overseas.

GM has been under a microscope since recalling 2.6 million vehicles, including the Chevrolet Cobalt, for a defective ignition switch. At least 13 deaths are connected to the safety issue. Kenneth Feinberg, who was retained by GM to administer a victims’ compensation fund, unveiled the details of his program last month.

On Thursday, GM recorded a $400 million charge to cover payments made through the compensation fund. The company has already paid a $35 million fine to the National Highway Traffic Safety Administration. The Department of Justice is also investigating the issue, which was brought to the attention of GM employees a decade before the recall was announced early this year.

Following the recall, GM launched a safety review of its entire portfolio. It subsequently recalled millions of additional vehicles, some for separate ignition-switch problems. GM logged $2.5 billion in repair expenses for recalls announced during the first and second quarters.

"I consider [GM] a 2015 story."

- S&P Capital IQ analyst Efraim Levy

But car shoppers have been undeterred by the spate of recalls. In the latest quarter, GM’s U.S. market share climbed 0.9 percentage points sequentially to 17.9%, or level year-over-year. North America market share was 17.2%, down from 17.3% a year ago but up from 16.5% in the prior quarter.

About 6,600 customers who owned vehicles covered by the switch recall purchased new models since mid-April, the company said. GM offered those customers employee pricing.

“I’m still positive about GM. I consider it a 2015 story,” S&P Capital IQ analyst Efraim Levy said, noting how new products should help drive earnings growth next year.

Total second-quarter revenue was up 1.3% at $39.6 billion, although it missed Wall Street expectations of $40.59 billion.

GM’s profit dropped to $190 million, or 11 cents a share, well below the year-ago period’s $1.2 billion, or 75 cents a share. Excluding one-time items, adjusted earnings were 58 cents a share, a penny shy of the consensus estimate.

GM shares were trading 3.4% lower at $36.15. Through Wednesday, the stock was already down 11.6% since the start of the year.

One-time items for the period included the charge tied to Feinberg’s compensation program, as well as an $874 million write-down for potential recall costs over the next 10 years. GM normally accounted for recalls as they occurred, but those future expenses will be logged as cars are sold. Warranty costs are handled in a similar fashion.

GM said Feinberg was consulted when determining the second-quarter charge, although there is no cap on the program. Compensation costs could increase another $200 million, according to GM, and the $400 million charge “is the company’s best estimate of the amounts that may be paid to claimants.”

A previously disclosed $1.2 billion charge for repair expenses wasn’t treated as a special item. During a conference call with analysts, chief financial officer Chuck Stevens said the decision “boiled down to a responsibility perspective.”

In Europe, where GM is phasing out the Chevrolet brand, the company’s loss almost tripled to $305 million. GM plans to reach profitability in the region by the middle of the decade. GM swung to an $81 million loss in South America.

GM’s international operations earned $315 million, up 36% over the year-ago quarter. However, revenue declined to $3.6 billion from $4.8 billion amid a weaker market share in China.

North America, by far GM’s largest market, saw net sales jump 9.3% to nearly $25.7 billion. Operating profit fell 30% to $1.39 billion, mostly due to recalls costs as GM sold more vehicles and reduced incentives.

Analysts have been keeping a close eye on North American profit margins, which reflected year-over-year growth for the fourth consecutive quarter. GM posted a 9.2% profit margin in the region, excluding recall costs, and executives believe GM is on track to hit its mid-decade target of 10%.

“The main thing is, directionally, they should improve,” Levy said.

When asked about GM’s pace of new product launches, Stevens said a “significant portion of the launch cadence is out in front of us.” The company will also focus on slashing costs and improving manufacturing efficiency, he added.

Automakers like Detroit-based GM, the nation’s top seller of cars and trucks, typically sell new vehicles at higher prices by scaling back incentives, thereby lifting margins.

Ford topped its Big Three rival with a North American pre-tax operating margin of 11.6%, an increase of one percentage point year-over-year. The company’s pre-tax earnings in the region rose to a new quarterly record of $2.44 billion, compared to $2.32 billion a year ago. Ford’s North America revenue fell 2.8% to $21.2 billion, largely due to fewer deliveries.

Elsewhere, Ford continued to benefit from growing market share in China and a rebound in the European car market. Ford reported total earnings of $1.3 billion, or 32 cents per share, compared to $1.23 billion, or 30 cents per share, in the same period last year. Revenue declined 1% to $37.4 billion.

Analysts were looking for per-share earnings of 36 cents and revenue of $36.16 billion. Shares rallied 1.1% to $17.98, extending a year-to-date gain of 15.2% as of Wednesday.

Ford posted a quarterly profit in Europe for the first time in three years. Ford cited favorable exchange rates, while a restructuring effort helped cut costs. Its pre-tax profit in Europe was $14 million, compared to a $306 million loss a year earlier.

Continued sales gains in China lifted the Asia-Pacific region to pre-tax earnings of $159 million, up from $130 million. Sales volume was up 26% in China, and Ford’s market share climbed to 4.6%. Looking at third and fourth quarters, Ford expects results the come in below the second period because of costs associated with new plant construction and the upcoming launch of Lincoln in the Chinese market.

Latin America was a weak area for Ford, with the segment swinging to a $295 million loss. Russia also presented challenges for Ford and GM, with both automakers showing concern over the country’s economy.

Ford is showing a good trajectory of progress in China and Europe, Levy said, reinforcing the notion that global car markets are on the upswing.

“China and the U.S. are strong and healthy. That bodes well for automotive participants,” Levy said.

Ford’s finance unit reported a pre-tax profit that fell to $429 million from $451 million.

The Dearborn, Mich.-based automaker cautioned that heavy spending on vehicle launches, including the aluminum-bodied F-150 pickup truck, will likely weigh on the company’s bottom line in the second half. Ford is revamping two manufacturing facilities to build the new 2015 F-150.

Levy expects Ford to reap the benefits of its new full-size truck in 2015. “Initial vehicles tend to be more fully loaded by early adopters,” he said, providing more opportunities for margin growth.

Mark Fields, who replaced Alan Mulally as chief executive at the start of July, told analysts that Ford is focused on “accelerating our pace of progress” established under Mulally’s One Ford plan. Fields rejected the notion that Ford needs “a new strategy because there’s a new person sitting in the chair.”