GM Cash Engine Churns On in the Dark

General Motors(GM) wowed the market with two impressive forecasts last week, sending its stock roaring higher. But how achievable are these targets?

The first, and most important, projection is that by 2005 the carmaker can earn $10 a share, up from the expected $3.50 this year. The second is that it can raise $10 billion of cash in 2002.

But a look at the numbers shows GM has based its projections on highly debatable assumptions whose sturdiness is difficult to pin down because of GM's unwieldy presentation of financial data.

Finance chief John Devine says that by 2005, GM could make an extra $6 a share from cost-cutting, $3 from selling more cars in North America and $2 from improving operations outside the U.S. This gives a total of $11. Meanwhile, pricing pressures would slash earnings by $4, Devine adds. The net boost to earnings would therefore be $7, which, added to 2002's expected $3.50, gets you north of $10. With its stock trading just shy of $60, GM is currently trading at only six times that $10.

Put that way, GM seems like a screaming buy. But GM may run out of gas before it gets to $10. For instance, the cost reduction number is truly Herculean. The $3 from volume may well be possible if the economy comes roaring back, which it's showing signs of doing. But GM's cheap financing may well have simply borrowed demand from future periods. And GM may lose more than $4 from pricing: Foreign automakers have killed the Big Three in car sales, and the big threat now is that they could make serious incursions into the light truck and sport utility vehicle markets, where GM's North American automotive unit makes most of its money. If the Toyotas and Hondas wanted to start a price war in these lines, GM could easily lose more than $4.

GM's treasurer Eric Feldstein argues that $10 won't be that hard to get to, since it implies companywide net income of 3% of revenue. GM, he says, has achieved this sort of net margin before. "That's not extraordinary at all," he says. "The assumptions to get there are not overly ambitious, and the cost reductions are in line with what we've achieved in the past."

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Feldstein also stresses the role of sharp drop in GM's share count in achieving the $10 target. In 1996, when GM had over 750 million shares outstanding, it took $7.5 billion of earnings to make $10 a share. Now that it has around 550 million shares, it can get to $10 with only $5.5 billion of earnings. "Our EPS is now turbocharged by share reductions."

It might be easier to have more faith in 2005 forecasts if GM could be a little more exact about projections for 2002, particularly the forecast that it can raise $10 billion of cash this year from various sources. The first proceeds from the pending sale of Hughes will bring in an estimated $4.2 billion, and the company looks set to raise about $4.3 billion to $4.5 billion from the debt markets. That leaves around $1.5 billion. Most of that is supposed to be coming from the all-important free cash flow, which is cash flow from operations after capital expenditures have been subtracted.

Knowing this number would give a good idea of the how much actual cash GM's core operations will generate, a useful figure given some of the noncash variables in the company's financials. When asked how much the automotive units and GMAC might produce, Feldstein replied: "We didn't specify." This is fishy. A shorthand for cash flow is net income with depreciation added back, adjusting for any changes from working capital. None of these components can be that hard to work out.

Could it be that GM is ashamed to say how little cash it might produce? If so, how can we trust an earnings number four years out?

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