Is the Voltage Wrong for this Car Manufacturer?

By Rita Chattaraj - September 17, 2012 | Tickers: GM, TSLA, TM | 0 Comments

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The future of the automobile sector lies in fuel efficient cars and the automobile giant General Motors (NYSE: GM) took a step in the right direction when it came out with Volt and delighted investors. But, the recent release from one of the world’s most valued sources, Reuters, left investors devastated. Reuters came out with a report which stated that GM is incurring a loss as large as $49,000 on each Volt. Let’s check out what’s going on and how true this claim is.

Based on the data from Munro & Associates, Reuters calculated the average cost of manufacturing a Volt to be $89,000 while GM is selling each Volt for $40,000, thus indicating a loss of $49,000 on each Volt. The number is huge and it’s only normal for investors to panic. But, a careful look will tell investors there is not much truth in this claim. According to GM’s management, the huge cost per car, as calculated by Reuters, is a result of inclusion of the one-time R&D costs in the total cost. Since December 2010, GM has sold around 21,500 Volts and analysts at Reuters have simply divided the total cost of manufacturing and the R&D expenses among these 21,500 Volts to arrive at the ridiculously high cost figure.

GM claims that the actual cost of manufacturing a Volt is somewhere between $20,000 and $32,000 mainly because of the variety of models and features and even Reuters accepted this. The report from Reuters focuses primarily on the total cost and not the marginal cost. The American car maker argues that as it goes on selling more Volts, the average R&D cost per car will come down and higher volumes will help to bring down the component cost and thus bring down the overall cost of production. Plus, the company also believes the $1.2 billion which it has spent on R&D has helped the company to develop a technology which will be invaluable to GM’s future growth. This being the case, it is not correct to assign the full cost of R&D to the Volt’s present model. The company plans to launch a new version of the car sometime in 2015 and even that 2^nd generation Volt will have the influence of the current R&D.

So, this clears the confusion regarding the $49K loss per car theory and it seems investors got worried for nothing. Or, were they right? If you ask me, investors were not wrong to be worried about their investment. Just the reason was wrong. Though the company is not actually losing a huge sum on each Volt it sells, there are plenty of other reasons to be worried about the company and its Volt venture.

GM’s argument that the average R&D cost per car and the cost of manufacturing each unit of Volt will come down with rise in volume is logical. But the question is will GM ever be able to sell enough cars to break even with Volt? Like I already mentioned, since December 2010, GM has sold 21,500 units of Volt as against the planned figure of 45,000 units. Because of the high price of the car, Volt sales have not reached the sales levels of Toyota’s (NYSE: TM) Prius. While GM sold 2,831 Volts in August, 2012, Toyota sold more than 20,000 units of Prius and with such high figures Toyota continued to dominate the industry. However, on a positive note, Volt has outsold Ford’s Focus Electric and Nissan’s Leaf in 2012.

Again, the market situation does not seem to be favorable for electric cars as consumers are still not fully ready to migrate to fully electric cars. Due to the low demand of electric cars, the market segment is likely to get saturated pretty fast and thus might not allow GM to sell enough cars to break even. Keeping in mind the $1.2 billion investment made by GM, the company needs to sell around 90,000-110,000 Volts to break even and the figure seems to be a little too high. Again, as new players decide to enter the market, GM’s hold on the space will continue to fall and thus create further problems for the automobile giant to restore the money spent on Volt. Comparatively, small players who haven’t invested in R&D as much as GM will need to sell far fewer cars to break even. Recently, Tesla Motors’ (NASDAQ: TSLA) CEO Elon Musk said that the company just needs to sell 8,000 units of its Model S cars to break even. Tesla has been producing good looking high-quality electric cars and enjoys a good reputation in the space.

With an intention to generate demand for its electric car GM came out with a cheap lease option and this can also turn out to be fatal for the car maker. The company is allowing buyers to lease a brand new Volt for two years at a cost of $5,000 and if these leasers don’t buy the cars after two years, GM will be badly hurt as the cars will lose most of their value by then and will be of negligible worth to the company. A situation such as this can result in huge losses and thus turn into GM’s worst nightmare. The company is in a tight position with Volt. Neither it can increase the price since that will diminish the car’s already weak demand, nor it can slash prices as that would hurt margins. With time, as these cars becomes more widespread and people start accepting them, car makers will have a less difficult time in making sales. However, till then GM will have to manage both ends properly. Else, it will end up with a huge number of unsold Volts in its storage facilities. Under the present circumstances I don’t think GM will be able to benefit much from Volt and all this makes me doubtful about the stock’s growth potential.

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