Updated from 3:24 p.m. ESTGeneral Motors ( GM) stunned the stock market Wednesday with an ominous profit warning, leading to speculation that the auto giant will be forced into a restructuring that could permanently alter the face of one of America's most enduring symbols of industry. Cutting its 2005 earnings outlook by more than half, the No. 1 automaker expects to lose $1.50 a share in the first quarter and earn just $1 to $2 a share for all of 2005. The company had previously predicted a break-even first quarter and earnings of $4 to $5 a share for 2005. The warning led Fitch to cut its rating of GM and GMAC's corporate debt to triple-B-negative, its lowest investment grade level. "Even though they had planned for some weakness early in the year, their business has been significantly weaker than expected," said Morningstar analyst Phil Guziec. "They've got huge operating leverage, so that crushes earnings." GM's stock closed down $4.71, or 14%, to $29.01, falling through its 52-week low of $33.69 and setting a 13-year closing low. The Dow Jones Industrial Average, meanwhile, lost 113 points Wednesday. GM has been a virtual spigot of bad news so far this year. Sales faltered in February, as the company announced it was cutting back on production. That followed a previous slash in earnings guidance for the year. Now, with the broader economic recovery gaining strength and foreign auto manufacturers rapidly stealing market share, an even deeper cut in guidance has prompted analysts to ponder significant changes in strategy at GM that could jeopardize its leadership position in the worldwide auto market. Having once laid claim to more than 50% of the U.S. market, GM now has just about half that, and its shares are still in decline. A boom in demand for sport utility vehicles and trucks in the 1990s silenced widespread predictions from the previous decade that Japanese automakers, like Toyota ( TM) and Nissan ( NSANY), would overtake their American counterparts. But with oil prices topping $55 a barrel and lighter vehicles coming back into fashion, the specter of a change in leadership has been raised again.
"Domestic manufacturers have had an excess capacity problem, and they've been having a price war to keep volume up and protect share," Guziec said. " Ford ( F) has been more aggressively conceding share and shrinking. GM may be coming up against the point where they have to do that. I don't think that will force bankruptcy, but if this continues, they'll have to continue to shrink down to a more appropriate size." GM's chief financial officer, John Devine, recently responded harshly to any mention of the "B-word," which has surfaced repeatedly in reference to GM lately, saying "the idea of bankruptcy is nuts." "I think there's going to be a restructuring of North American operations with an aggressive cost-cutting program coming that will involve closing more plants and laying off more people," said Burnham Securities analyst David Healy. "They may even go back to the unions and try to get concessions on health care and other costs." GM's previous first-quarter earnings guidance was based on North American vehicle production of 1.25 million. Since then, production schedules have been reduced by about 70,000 vehicles and pricing has become more competitive in North America. GM also expects negative operating cash flow in 2005 of approximately $2 billion before charges related to its settlement with Fiat and the restructuring of its European division. It had previously targeted positive cash flow of $2 billion. The revision is primarily attributable to lower volume and decreased net income at GM North America. Meanwhile, the company swims in a swamp of rising steel and fuel costs, shifting consumer attitudes and soaring legacy costs for pension and health care requirements that add a reported $1,850 to the cost of every vehicle made. Its $50 billion of corporate debt is currently rated at BBB- at Standard & Poor's, the agency's lowest investment grade level. Its debt is the second-largest component of the Lehman Brothers corporate bond index behind Ford.
GM's corporate debt has been trading at junk spreads for several weeks and those spreads widened sharply as Standard & Poor's lowered its outlook on GM and its finance arm to negative from stable, setting the stage for a possible downgrade of the world's biggest carmaker to official junk status, which could have
widespread implications for the corporate bond market . "My guess is that all the rating agencies are probably going to knock the company's rating down one more notch to junk," said Healy. The companies plans to dig its way out of this hole will probably focus on its North American auto operations, since the company said Wednesday's guidance reflects "lower North American sales and production volumes, a tougher pricing environment, and a more car-based sales mix. At the same time, GM's other automotive regions and GMAC are all on track to meet or beat their 2005 net income targets." For the last three years, GM has derived the lion's share of profit from its financing arm, General Motors Acceptance Corp. In its release Wednesday, the company said GMAC "is on target to exceed expectations" despite higher interest rates and wider spreads. "Much of GMAC's success stems from its ability to diversify its funding sources," GM said in a release. "We're confident that GMAC can continue to sustain strong levels of profitability." GM has reportedly weighed a spinoff of GMAC in recent months as a way of shielding the parent's corporate credit rating from the possibility of a ratings-agency downgrade. Barry Ritholtz, chief market strategist with the Maxim Group and a contributor to RealMoney.com, said he would consider buying shares of GM in the low $20s. But he is concerned about the survival of the company's dividend, which currently offers a yield of 5.9%. "Is the dividend safe?" Ritholtz asked. "I've got to think that if they're announcing a $1.50 per share loss, the dividend is in danger. "This is all just a continuation of years and years of terrible management, uncompetitive brands, a high fixed-costs structure, and bad cars," Ritholtz added. "There's no other way to say it."