Good News For GM: It Isn't Really Losing $49,000 On Every Volt

| About: General Motors (GM)

Monday morning saw one of the most bizarre finance news stories I have seen in quite a while. Reuters reported that General Motors (NYSE:GM) is losing roughly $49000 (the math was a little fuzzy) on every Chevrolet Volt it produces. Naturally, the story was picked up by multiple outlets that syndicate Reuters. The article opens with this memorable line: "General Motors Co sold a record number of Chevrolet Volt sedans in August - but that probably isn't a good thing for the automaker's bottom line."

There's just one problem: the claim is based on complete ignorance of basic economics and the principles of finance. If you read the full article (which is quite long) the authors eventually add some qualifiers and a little more detail. But the general impression created is that for every Volt it sells, GM sinks deeper into the red. In fact, the opposite is the case. While the Volt program has been a mild disappointment so far, GM does benefit from increasing the Volt's sales, particularly because higher volumes will decrease component costs. Moreover, the technology developed will be invaluable to GM's future growth.

The key fallacy in the Reuters article is that it focuses on the total cost of the vehicle program, rather than the marginal cost (which is the gross margin for the Volt). As the article points out, the Volt's development costs were over $1 billion. InsideEVs points out that the Reuters writers simply portioned those costs out over the 21,500 Volts that GM has sold in the U.S. thus far. But the actual cost of manufacturing the car is somewhere between $20,000 and $32,000, (also according to Reuters). Perhaps some of the variability is the result of different options for the vehicle, but the range still seems unusually wide.

For simplicity, let's conservatively assume that the base manufacturing cost is $30,000. Even allowing $4000 for incentives, marketing, logistics, the dealer's profit, and other Volt-specific selling costs, that still leaves GM with a profit of $6000 per vehicle at the $40000 base price. If these ballpark figures are roughly accurate, then the Volt has contributed over $100 million towards its development costs, less than two years into production.

Now, it is true that GM is not on pace to recoup the full investment of over $1 billion by 2015, when the 2nd generation Volt is expected to appear. Due to its high price, the Volt has not approached the sales levels of the Toyota (NYSE:TM) Prius, which currently dominates the hybrid market. While GM delivered a record 2831 Chevy Volts in August, Toyota's Prius sales exceeded 20,000. On the other hand, the Volt has outsold Nissan's electric-only Leaf by more than 3-to-1 in 2012. With gas prices remaining stubbornly high in recent weeks, adoption of hybrids will probably continue to increase. The Volt should achieve at least a proportionate uptick in sales.

If the Volt can average 2000-2500 sales per month over the next three years, that will add roughly 80,000 units over the product's lifetime. Including perhaps 50000 total sales of the identical Opel Ampera, you have roughly 150,000 vehicles for the full life of the first generation Volt/Ampera. When you divide the Volt/Ampera product development costs over 150,000 vehicles (over the course of five years), it turns out that the program gets close to breakeven.

Moreover, it's not clear that the full costs of the Volt's development should be assigned to the first generation model. GM had to develop numerous technologies to produce its first plug-in hybrid. Rapidly rising CAFE standards in the U.S. will make these technologies very valuable to GM's future development. It would not be surprising to see Voltec technology in a significant percentage of GM's vehicles ten years from now. Defraying the Volt's development costs over this much larger base will show that GM's investment in the Volt program was very far-sighted (unlike most of the company's decisions prior to its 2008-2009 reorganization).

There are some reasonable points in the Reuters article. For instance, in recent months GM has been resorting to more leases rather than sales to move the Volt. This could lead to future losses if the Volt's resale value is lower than expected. However, Reuters' main point (that additional Volt sales widen GM's losses) is false, pure and simple. There's a reason why other companies are itching to get into the plug-in hybrid business, such as Ford (NYSE:F) with the C-Max Energi and upcoming Fusion Energi. Honda (NYSE:HMC) also hopes to enter the game next year with the Accord plug-in hybrid. Fuel efficient cars are the future, and the Volt was the first step in the right direction for General Motors. Reuters' claim to the contrary was simply the result of awful research and reporting.

Disclosure: I am long GM, F. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.