Should GM, F Say Goodbye Europe?

By Callum Turcan - August 6, 2012 | Tickers: F, GM, HMC, TM | 0 Comments

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European Weakness

In June, Europe's unemployment rate was 11.2%, a record high. Germany is fairing far better at 5.4% while France is floundering at 10.1%. The OECD estimate for euro zone growth is for a contraction of 0.2% this year and for 0.9% growth in 2013. They also estimated that the unemployment rate would hit 11.1% by the end of the year. Now, these estimates were made in May, and since then the unemployment rate has surpassed their estimate. This is bad news bears. This shows us that Europe is heading for a deeper recession which will cripple corporate earnings across the board for any company unlucky enough to have European exposure.

The disease Spreads

With 40% of China's GDP made up of exporting goods to the US and Europe. So, if Europe has weakness, so does China. With China being one of the few sources of growth in the world, when GDP starts to fall, investors panic and consumers lose confidence. If China's GDP growth slows, so does its needs for commodities, which in turn hurts major commodity producing regions (like South America). Plus, as you all know, European weakness hurts the US as well. This is known as the domino effect (or simply a global economy).                    

Auto Profits?

Last quarter, General Motors Inc (NYSE: GM) lost $361 million in Europe, compared to a $102 million profit last year. Ford Motor Company (NYSE: F) lost $404 million last quarter in Europe as well, and expects to lose $1 billion in Europe, double their original $500 million estimate. Both GM and Ford are getting hit hard and it is clearly reflected in their stock price. Also, one funny fact is that GM hasn't had an operating profit in Europe since 1999. 1999! 13 years later and still chasing good money after bad, which is never a good idea. Plus, GM's management has no idea just how much money it is going to lose in Europe. Neither does Ford really, but at least they tried to give some guidance.

Chasing Good after Bad

Ford spent an extra $189 million in incentives in Europe last quarter than the previous quarter just to try to bring consumers in, but all this led to was smaller margins (or larger negative margins) and a large loss. When you are spending extra money just to lose money, you have to wonder what management is thinking. One thing Ford does get right is it sells the same cars and trucks in every country, so it can spend money more efficiently on research and development, which is much better than having to spread the R&D budget around, building different cars and trucks in each region. General Motors doesn't do this, so it has to spend more money on R&D to get similar results. So every time Opel and GM's Europe division spends money on R&D, it is money that wouldn't have had to be wasted if it had taken Ford's approach.

European Auto Sales

European auto sales have been sliding down a cliff for some time now. According to numbers released by the European Automobile Manufactures' Association, Italian auto sales fell 26.7%, France was down 23.2%, Spain was down 4.5%, Portugal was down 49.2%, Cyprus was down 35%, and Greece was down 42.6% (all year over year, and Spain had a very tough 2011 Q1, which is why it "seems" it's not that bad in Spain). As you can see from the graph, European auto sales are disappearing by the day. This has pushed auto sales down to 1994 levels. As far as anyone can tell, these sales will continue to decline for a while, as Italy's economy is expected to contract 2.4% this year and 0.4% next year. Combine this with France's stagnation and a slowing Germany (which is the largest European auto market), and it seems to be that European auto sales aren't going to recover until the structural problems of Europe are fixed. 

Others

Honda Motor Co (NYSE: HMC) lost 7.6 billion yen ($95 million) in Europe in their latest quarter, which is up from the 6.1 billion yen ($76.25 million) loss it had in Europe in the same quarter last year. Honda posted huge sales growth in North America at 66%, 61% in Japan, 37% for Asia (excluding Japan), but the only region where sales fell, you guessed it, was Europe. European sales were down 2% while every other region was firing on all cylinders. Toyota Motor Corp (NYSE: TM) only has 4% of the European auto market share, which is about 10% of its overall sales. Because of this limited exposure, it was able to see an overall rise in European sales in its latest quarter. So some automakers are finding ways to get by and weather the storm.

Benefits of Leaving

The two main players that would benefit from leaving Europe are GM and Ford. If Ford was to leave Europe, assuming that they are going to lose $1 billion dollars there this year, at a PE of the current year’s estimate of 6.9 Ford's market cap of $34.7 billion would increase by $6.9 billion. That would cause a 20% bounce (in theory) to Ford's stock price. Not bad. Plus, that extra $1 billion a year could be put towards paying down debt and expanding into Asia's booming market (which is pegged to be at 16.09 million according to China's automotive ministry), which would further increase Ford's stock price. Also, if you take away the uncertainty investors are placing in Ford due to Europe, it could go higher. Now, if anyone should leave Europe, it would be General Motors. GM hasn't posted a profit in Europe for 13 years, and according to its management, won't anytime soon. Every dollar GM puts into Europe is a dollar wasted. GM should sell off Opel and GM Europe and exit Europe entirely. The reason why GM's stock price is trading $20 and not $25 or $30 is because of all the uncertainty investors are placing in GM's stock because of European problems. I don't know how high GM's stock would go if it exited Europe, but I wouldn't be surprised to see $30 in the near term and in the long term to see stable profit generation and the possibility for the US to exit at a profit ($53 a share).

Final Thoughts

While I don't think Ford, General Motors, Toyota, Honda, or any other major auto maker will leave Europe anytime soon, I do think GM stands to gain the most if it does leave. It has lost money for over a decade and will continue losing money in Europe for a long time. Ford would also stand to gain from leaving Europe, but if Europe's economy turns around it would probably want to be there making money. Unlike GM, Ford has been profitable in Europe and would benefit from staying in Europe for the time being, but Ford should shed a large part of its production, as it is doing. All players in Europe should cut down on their production in Europe due to large drop in demand which will continue to push auto sales lower for some time. Toyota is doing very well because it has limited exposure to Europe. Europe will continue to be a mess for some time, and I would strongly advise GM to simply pack its bags and leave the arena.

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