Locating the GM 'Crisis'

It cites health care costs. Others wonder about product mix.
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Updated from 10:11 a.m. EDT

The March profit warning from

General Motors

(GM) - Get Report

became a reality Tuesday as the company swung to a $1.1 billion first-quarter loss and dropped hints that it is ratcheting up pressure on organized labor.

The world's largest automaker, whose hundreds of billions of dollars in debt remains poised just above junk status at the three main ratings agencies, said automotive cash flow was a negative $3 billion in the quarter, while cash and equivalents held in a trust for employee benefits were $19.8 billion at quarter's end, down from $23.3 billion at Dec. 31.

While the ugliness was widely expected, GM rattled investors anew by refusing to offer new guidance for 2005. The company cited uncertainty about the "resolution of the health care cost crisis," a reference to its troubled negotiations with the United Auto Workers union.

The statement suggests that "management is ratcheting up pressure on the UAW to open the current contract, which expires in the third quarter of 2007," wrote John Casesa, a Merrill Lynch analyst, in a research note.

GM is trying to force its unionized hourly workers to pay the same portion of their health insurance premiums as its white-collar workers pay. Currently, GM's white-collar workers pay about 27% of their health care premiums, while its hourly workers pay about 7%.

"Our view is that concessions are unlikely before 2007," Casesa said. "Today's statement underscores that restructuring GM's North American operations will be a long, arduous process."

The biggest hit to GM's first-quarter performance came from its North American automotive operations, which racked up $1.3 billion of red ink. In addition to rising cost pressures, the division was hurt by lost market share to competitors such as


(TM) - Get Report

, whose fuel-efficient and affordable vehicles have increasingly caught the favor of consumers. GM's North American market share dropped to 25.2% in the 2005 quarter compared with 26.3% a year ago.

On a conference call with analysts, GM's vice chairman and chief financial officer, John Devine, was careful to stress that improving the company's product mix was a priority, but he also said he was focused on cutting costs, particularly in healthcare. He expects GM's health care costs to be $5 billion in 2005, up about $1 billion over last year.

"That's been going up in particular in the last couple of years," Devine said. "It's put a real drain on profitability, cash and a big dent in our balance sheet as a result of that. We think there is a potential for that to continue with heath care inflation the way it is."

Morningstar analyst Phil Guziec said the company has shown a propensity for "disproportionately complaining" about health care. He said the company needs to focus on making its products more competitive.

"Our first issue is our product mix, and our second issue is to get healthcare costs down," Devine said. On the other hand, management offered little in the way of specific actions to improve its product mix.

One big factor in its first-quarter sales declines was production cuts. GM's inventories were down by about 100,000 units in the first quarter.

"We think it's the prudent thing to do, and we're doing it aggressively," said Devine. "I would expect a further reduction in the second quarter, but we're not putting any magic number. There's obviously a lot of time between then and now. There's three months of sales that we have to see, and every month is an adventure, so stand by."

On the bottom line, GM lost $1.10 billion, or $1.95 a share, in the quarter, compared with earnings of $1.21 billion, or $2.12 a share, last year. Net revenue was $45.77 billion, down from $47.83 billion a year ago.

Backing out charges and tax adjustments that totaled $265 million, or 47 cents a share, GM lost $839 million, or $1.48 a share, in the quarter, a penny narrower than the Thomson First Call estimate.

The company said its automotive operations lost $1.3 billion in the first quarter, compared with earnings of $561 million a year ago. The loss reflected a $1.3 billion loss in North America, compared with earnings of $401 million a year ago.

In its best-performing business, General Motors Acceptance, earnings slipped to $728 million in the 2005 quarter from $764 million a year ago. Financing earnings fell to $248 million from $442 million, while mortgage operations earned $385 million compared with $231 million.

"GMAC delivered solid results in a very challenging environment," the company said. "Although interest-rate pressures have grown, GMAC has been very adept in funding its businesses and maintaining a strong liquidity position." At the end of the first quarter, GMAC had a balance of cash and certain marketable securities of $18.5 billion.

GM expects total U.S. industry sales in the second quarter of 2005 to come in at a seasonally adjusted annual selling rate of around 17 million, about flat with the selling rate in the first quarter of 2005. While the company expects industry-wide sales to pick up in April, it said its own results would come in lower than its results in the same month one year ago.

Beyond that, GM said any guidance about its future performance was "inappropriate" at this time.

"I think it's going to be ugly for at least a year," Guziec said.