Auto Industry Can Sustain More Incentives

DETROIT February 25, 2004; Sharon Silke Carty writing for Dow Jones reported that there are indications the auto industry can sustain a moderate rise in incentives, J.P. Morgan analyst Himanshu Patel said Wednesday.

In a research note, Patel said General Motors Corp. reported only a small drop in its profit margins in 2003, from 6.2% at the peak of the industry in 2000 to 5.5% in 2003.

"GM's relative underlying margin stability since 2000 suggests that the U.S. industry (and GM in particular) has been able to significantly offset chronic pricing pressure with cost cutting and enrichment," he said. "As such, we think a modest level of future incentive growth, while not desirable, is tolerable by the industry."

Rising pension and healthcare costs have hurt the automaker's bottom lines, masking an underlying strength in profit margins, Patel said.

"By no means are we implying that pension and healthcare costs are somehow artificial and that they need not be considered in a company's valuation," he said. "In the case of the Big Three, these are clearly integral parts of the equity story."

Still, GM's underlying profit has been resilient, the analyst said. When the effects of pension and healthcare are taken out, GM's 5.5% 2003 profit margin is higher than the company's 10-year average of 5.2%.

"In our view, this reported and underlying margin comparison seriously calls into question the conventional wisdom in the investor community surrounding the recent U.S. incentive battles," Patel wrote.

As for Ford Motor Co., Patel said pension and healthcare costs have hidden improvements in the company's profitability. Excluding those costs, Ford's pretax profit margin came in at 5.8% in 2003, compared with 11.3% in 2000. While that's a steeper drop than GM's, it's better than figures most investors have been using. Most have been looking at the pretax margin, including pension and healthcare costs, which was 2.1% in 2003, compared with 9.9% in 2000.

Patel doesn't own shares of either company, but J.P. Morgan has a banking relationship with GM.