GM: Recalls, Liability, And Boeing

| About: General Motors (GM)
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GM CEO Mary Barra testified to Congress as public pressure intensifies over GM's late recall over an ignition issue.

While the bankruptcy may have cleared the firm of legal liability, GM will have to compensate victims to protect its brand equity.

The Boeing recall shows investors should buy before the crisis is resolved.

Shares of General Motors (NYSE:GM) are down 16% so far in 2014 and currently sit near the year to date low as the company deals with the fallout from its faulty ignition switch. CEO Mary Barra testified before a House committee on Tuesday as outrage grows over GM's apparent cover-up of the problem that has led to 13 deaths. Barra has been aggressive in dealing with this problem, and GM has recalled over 7 million vehicles this year, more than it has recalled over the past four years combined (details of the recall issue can be found here).

GM's problem has been getting tremendous attention because it has so many components. There is the tragedy of those killed due to the faulty ignition. When discussing the recall or the stock, it is important to remember the loss of life, and no matter on where you stand on how GM should deal with liability going forward, we should remember the victims and their families. In addition to the tragedy, there is an element of corporate greed as it seems GM avoided fixing the ignition switch to save money despite the loss of life. Finally, there is the political undertone. GM was aided by US taxpayers and filed for bankruptcy in 2009. New GM, the one that emerged from bankruptcy, does not have the liability issues that shackled GM during the crisis. This likely includes protection from any claims involving the ignition switch prior to 2009 (more details on the liability issue here).

GM is in a tricky position. While it likely lacks civil liability, there is probably some moral responsibility. Further, there is definitely a brand issue. Recalls hurt a brand, but refusing to provide any financial aid to victims' families could devastate GM's brand equity. Thus far, GM seems to be riding out the storm as its March sales were up a solid 4% (all financial and operating data can be found here). A failure to pay out anything could impact sales in the future though. As a consequence, GM has hired liability claims expert Ken Feinberg to advice on this delicate situation.

As a shareholder in GM, paying out something to victims makes financial sense to me (this is aside from any moral view of the situation). GM's auto unit also carries $21 billion in net cash. In other words, the company can afford to make things right without endangering its financial position or juicy 3.5% dividend. In an increasingly competitive market with Ford (NYSE:F) launching innovative products and foreign automakers offering more discounts, maintaining brand equity and loyalty is critical. It is likely a better strategy for GM to ignore the fact it might lack legal liability and do what is right. This strategy will help GM maintain brand equity and keep it from losing customers to rivals.

At the end of the day, pressure from this recall will eventually recede. While there are some differences, I think investors should look at Boeing's (NYSE:BA) recent problem as a way to trade GM. In January 2013, Japan Airlines had a battery fire on board at Logan International Airport in Boston. As a consequence, Boeing 787 Dreamliners were grounded around the world as Boeing tried to find a solution for the problem. On March 7, the National Transportation Safety Board released a factual report discussing the problems with the battery while reporting there were no structural issues with the plane. Finally on April 5, Boeing had found a solution to the battery problem. After implementation, the FAA allowed 787s back in operation on April 26, 2013 (details of this problem available here). Here is how Boeing's shares performed during this period:

(Chart from Google Finance)

As you can see when the issue came out in January, BA shares pushed a bit lower and then flat-lined while the S&P 500 rallied. In March, Boeing began to rally as a solution seemed more likely and were up nearly 20% before the final fix was implemented. If you sold on the bad news and waited for a solution, you would have missed out on the rally. Instead, you were best to buy as the news was bleakest. I think the same will hold true for GM. The best strategy is to buy shares while the overhang persists. Once the problem is in the rear view mirror, GM shares will be higher.

Now, there are some differences between Boeing and GM that should be noted. First, Boeing successfully dealt with its problem. We cannot be certain that GM will. If GM really botches handling the fallout, shares may not rebound so swiftly. However, Boeing faced a complex engineering issue while at this point GM is really dealing with a PR issue over an ignition problem from years ago. If anything, this crisis is easier to solve. I expect GM will deal with this problem in a way that protects the brand and future sales.

Also, Boeing's clientele is mainly other corporations, the airline companies. GM sells mostly to individual consumers. Business customers are often focused more on long-term economics while consumers can be swayed by brand value. Airlines had a lot invested in the Dreamliner and its significant fuel savings and would be patient before they would even consider switching to Airbus. As a consequence, Boeing could work deliberately behind the scenes to fix the problem while keeping the support of its customers. Auto customers could be less patient and more inclined to shop elsewhere the longer this drama plays out, which makes a solution all the more important.

Boeing is proof that massive problems are not the death-knell of great companies. When they find solutions, the company can perform well. Shares are up another 35% since the crisis last year. GM can move past its recall problems by treating victims fairly, being transparent with the issues, and putting in procedural safeguards that emphasize safety. As Mach auto sales showed, customers have not fled from GM. If more bad news come out, shares could push lower. Still with $4 in earnings power, shares are exceedingly cheap at current levels. The lesson from Boeing is to buy on weakness and not wait until the good news out. Now is the time to slowly build or add to a position in GM.

Disclosure: I am long GM, F, BA. 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.