American automaker General Motors (GM) reported fantastic third quarter results Wednesday morning. The firm shrugged off European weakness to grow revenue 2.5% year-over-year to $37.6 billion, nearly $2 billion better than consensus estimates, even though it was negatively impacted by $1 billion of currency fluctuations. Earnings were also much better than expected, falling 9% year-over-year to $0.93-about $0.28 higher than consensus expectations. EBIT (earnings before interest and taxes) actually ticked up $100 million to $2.3 billion, so if it wasn't for higher tax rates, earnings would have been comparable to last year. For a read on how we value General Motors, please click here.
Though revenue in North America grew 7% year-over-year to $23.3 billion, EBIT in the region tumbled 17% to $1.7 billion. Operating margins fell substantially, down 220 basis points year-over-year to 7.8%. This situation is drastically different from what we saw at Ford (F), which leveraged 12% operating margins into huge earnings growth. Management hopes new products and shared platforms will help close the gap with Ford, though we would be pleased if GM can consistently post operating margins between 8%-10%.
As with Ford, the return of Toyota (TM) and Honda (HMC) weighed on US market share, which fell to 17.6%. Ford's F150 with EcoBoost is simply beating everyone else in the truck space, while we think Volkswagen's luxury brand, Audi, is negatively impacting sales of Cadillac, as both share similar price points. Both Chevrolet trucks and Cadillac underperformed the broader company. Still, we maintain that new products and platforms will help improve profitability going forward. The company believes the fourth quarter will be stronger than last year.
European results were abysmal, with revenue falling 18% year-over-year to $5 billion, driving the company's loss in the region to double to $478 million. As with Ford, the firm now needs to cut excess capacity in the economically-plagued region and says it will reduce headcount by at least 2,700 workers. Losses in Europe are expected to total $1.5 billion-$1.8 billion for the year, with 2013 being marginally better. After inking a huge sponsorship deal with iconic soccer club Manchester United (MANU), it has become evident that GM doesn't want to give up on Europe, though it may be time to consider selling Opel. We're not quite as confident in management's ability to right-size the European operations as we are about Alan Mulally's team at Ford, but losses can't balloon much more, in our view. Mid-decade breakeven sounds a little optimistic.
On a more positive note, GM continues to outpace other vehicle manufacturers in China. GMIO (International Operations), which includes Indian and Chinese joint-ventures, saw EBIT surge 89% to $689 million, on a modest 10% increase in revenue. China will eventually become the world's vehicle market, and GM has used its first-mover advantage to become one of the dominant players in the highly-fragmented market. China could become a huge cash cow for GM, likely emerging as the first or second largest segment within the company. GM South America also swung to a profit of $114 million, and though less important at the moment, also represents some great growth potential.
In addition to strong geographical results (ex-Europe), the automaker generated fantastic free cash flow of $1.2 billion, 3 times greater than the amount generated during the third quarter of 2011. Further, 30% of eligible retirees accepted pension buyouts-far greater than the company initially predicted. As a result, $29 billion of pension obligations will be eliminated compared to a previous estimate of $26 billion. The company will only have to contribute $2.6 billion to the pension fund during the fourth quarter, compared to earlier estimates of $3.5 billion-$4.5 billion.
Overall, we liked the quarter, as well as GM's demonstrated ability to generate gobs of cash flow. With several tax assets in the US and Canada, the company will avoid paying too much in taxes going forward, further bolstering its cash-flow profile. Though its operations aren't yet as refined as those of Ford or Toyota, GM continues to make strides to becoming a leaner and more profitable company. And even though we still prefer Ford in the portfolio of our Best Ideas Newsletter, this third quarter performance by General Motors has solidified the firm's comeback, in our view.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
Additional disclosure: F is included in our Best Ideas portfolio.