GM Recall Charges Could Wipe Out 50% of Profits

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When is an accounting charge wrong? Usually when it is too low. General Motors Co. (NYSE: GM) has set aside $1.2 billion as a charge to earnings for the current quarter due to the recall of 29 million cars and light trucks. The number is a management guess, blessed by accountants, whose guesses may not be any better. The eventual charges, based on the scope of the car company’s problems, could be much higher.

The GM charge makes several assumptions that may not be true. The first is the cost to actually repair broken cars, many of which have faulty ignitions. Another is the amount that GM will need to pay out to those who were injured or to their families. This will be the work of Kenneth Feinberg, who has performed related work for other large companies, the most visible of which was BP PLC (NYSE: BP) after the Deepwater Horizon disaster. However, Feinberg’s program covers only 2.6 million cars. GM’s responsibility for the dead and injured may extend to other cars. And some of those people covered by Feinberg’s plan may reject the offers and take their chances in the legal system, where there is some chance GM will lose.

Additionally, GM faces charges from some state and municipal authorities. The Orange County District attorney has filed an action against the America’s top car company “for endangering motorists and the public by intentionally concealing serious safety defects in GM vehicles to avoid the cost of a recall or replacing defective parts.” Several state attorneys general have begun to explore similar legal actions. Investors may sue GM as well for the loss of their investment, as GM’s stock has tumbled.

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The eventual size of GM’s legal risks, and the costs to repair as many as 29 million vehicles, is incalculable at this point. Whatever the costs, they can be measured against GM’s net income, which was $5.3 billion in 2013 and $6.1 billion the year before. The charges GM has announced for now approach a quarter of those numbers.

Based on the huge hurdles GM faces, the odds are small that its earnings charge estimates are too high. More than a quarter of GM’s profits are at risk because its potential liabilities keep growing. However, over the course of this year, at least, much more of the company’s bottom line will be eroded.