“Clearly, this took too long”; GM Recalls 1.5 million Vehicles

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Edited by Vani Rao

Recalls highlight that it is not able to fix its early problems

General Motors (NYSE:GM) announced on Monday, March 17, 2014, about three new recalls  not related to last month’s ignition switch recall that involve more than 1.5 million vehicles. The automaker also said it will take a $300-million charge against first-quarter earnings to pay for the four recalls. Last month’s switch recall of 1.62 million vehicles worldwide has triggered federal investigations into why GM knew of a switch problem as early as 2001, but recalled the cars only last month. Twelve deaths and 31 crashes have been linked to the switch recall.

The company also announced on Tuesday, March 18, 2014, about the hiring of a new vehicle safety chief who will be in charge of helping the automaker reverse course after an avalanche of high-profile safety issues. Revelations that GM did not act for 13 years on information that its ignition systems in some smaller cars might impair the operation of the airbags and put car owners at risk was greeted with surprise and dismay.

The same bad practices that defined GM for decades have not gone away and this latest issue of product safety is just a current example. It seems that GM knew of the problem, hid it from the public until it could no longer be hidden, and now is profusely apologizing for the “terrible things” their actions gave rise to. The apology is likely hollow for the survivors of those who lost their lives in GM vehicles as a result of the ignition issue, and is unlikely to stall an exodus of customers who will seek alternative vehicles from manufacturers that maintain higher standards of product quality.

Source Bloomberg
Source Bloomberg

GM’s stock has declined about 6.5% more than the S&P 500 over the past three days, losing nearly $3.5 billion of market capitalization as a result of a new round of negative fallout from the faulty ignition switch recall. The recall itself is not a particularly damning issue, but revelations that the company was aware of the issue for 10 years prior to taking action is highly problematic as evidenced by the consequent calls for Congressional hearings and internal investigations.

Reputation Risk: The Key Negative

Recalls are an inevitable cost of doing business when you sell a highly complex product that interacts with people and is very heavy and fast. The direct cost is probably no more than $500 million or about 5% of this year’s consensus EBITDA estimate. I reckon that as $200 per replaced switch times 1.6 million units plus $1.5 million times 31 accidents plus $10 million times 13 fatalities. The actual cost will probably be lower because an ignition switch is about a $50 part plus $100 of labor charges required for installation.

The key negative impact is the overhang from the Department Of Justice (DOJ) criminal investigation, which could take years for closure and for which there is little visibility in terms of financial or other impact. The high-profile house panel investigation is also negative for the company but its impacts are only short term.

Although GM has offered to mend the damage done, the fact that the company knew about the major safety hazards of its vehicles and resulting fatalities, and yet waited for so long to recall its vehicles presents a significant reputational risk. The company no longer sells the recalled models, but customers might raise concerns regarding its ability to address similar problems that might occur in its current models, thereby hampering future sales.

The bigger issues for investors are the potential long-term market share impact and what this reveals about GM’s corporate culture. GM’s liquidation’s market value has declined about 9% (or $80 million) over the past three days, which implies the reputational damage is about $3.4 billion. With regard to market share, the bungled recall will prove to be the result of overly-complex bureaucracy and that in the absence of intentional malfeasance, it will blow over in time. To put the current recall in context, below is a list of the top 10 recalls from the past decade according to Automotive News.

Source Automotive News
Source Automotive News

Cultural change in an organization as large and risk-averse as GM takes a long time. The bankruptcy created a crisis that did enable some improvement, but that impetus has receded with the subsequent commercial success. Perhaps this recall is just the wake-up call GM needs to further streamline more of its mid-level bureaucratic tangle.

Recalls never auger well for car companies since it results in high costs to fix the issues that caused the recall in the first place. Considering that the auto industry usually has to work with low margins (most car companies will have operating margins of 5-7% due to high costs of materials, labor, production and marketing), having a large recall can eat into a good quarter’s profits.

Secondly, when a car company issues a recall, many owners of these cars are inconvenienced as they have to bring their cars to a service location, rent another car (which may or may not be covered by the company issuing the recall), wait anywhere between a few hours and a few weeks before they get their car back and deal with the stress of entire recall. Furthermore, if their car is not fixed correctly in the first attempt, this will increase the amount of stress faced by these people. Obviously, if a person buys a GM car, goes through a stressful recall process and remembers it, he may be less likely to buy another GM when it is time to shop for a new car. People tend to remember bad experiences more often than good ones.

Thirdly, a car company will have to increase its marketing and public relations spending after issuing large recalls because these recalls can have a negative impact on people’s perception of the company. When Toyota Motors (ADR) (NYSE:TM) issued several large recalls between 2009 and 2011, these recalls reduced the company’s perception and sales considerably and helped Ford and GM make good. After this, Toyota had to invest heavily into marketing in order to fix its public image even though the company had one of the strongest brand images in the world prior to these recalls.

Large recalls can also bring up additional scrutiny from governments around the world. When a car company issues a large recall, governments of various countries will take notice and will conduct an investigation regarding the issue. Often, these investigations can trigger additional recalls, where it almost looks like a chain reaction.

Last month, GM’s stock price fell sharply and this is likely to attract a lot of bargain hunters who will be looking for a cheap stock with a decent dividend yield. GM’s current yield is around 3.50%, which is high enough to gain attention of dividend investors. However, the company does not have a long enough history of paying dividends, making it difficult to draw any trend from the current situation.

Compared to other car companies, GM’s earnings multiples (based on the trailing 12 months) are not exceptionally attractive either. Many people expect GM to expand its margins, improve its profitability, and improve earnings. This will seem increasingly unlikely if the company continues to issue expensive recalls.

Source Ycharts.com
Source Ycharts.com

Of course, GM is not the only car company that issues large recalls. Most large car companies have a long history of recalls; however, every company needs to improve its quality control processes and make sure that these recalls are as minimized as possible if it wants to have a shot at growing its profits by expanding its margins.

GM’s recent woes come just as the automaker was finally shaking off its last big public controversy. The US Treasury Department sold the last of its GM stock last December, ending the Federal Government bailout of the automaker after four-and-a-half years and $12- billion in taxpayer money that was poured in to keep GM afloat.

The Justice Department and the National Highway Traffic Safety Administration (NHTSA) are investigating GM’s handling of the ignition issue, and at least one large-scale class action lawsuit has been filed on behalf of car owners. Mary Barra, CEO of GM, is expected to testify before Congress as part of the investigation, but for the moment, GM is not admitting liability in any accidents that occurred before 2009, according to press remarks that the GM CEO made on Tuesday, March 18, 2014.


GM’s stock is overly beaten by the negative news about the vehicle recalls. Although the company faces a significant reputational risk due to a decade-long delay in resolving the issue, the negative reaction was overdone. Even if we assume a huge $2-billion Federal fine, it would still be less than the initial hit that the stock took. The reaction is simply not justified, keeping in mind the facts discussed in the article. It provides a very attractive long-term entry point, especially keeping in mind GM’s cheap valuation and excessive liquidity. However, the company needs to address the all-important concern that internal issues that caused the delay in recall have been resolved.

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