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Revenue: There Is No ‘There’ There, Part II

Sunday, September 5, 2021

By Jason Apollo Voss

In last month’s column, I used Motorola as a case-study to explore the importance of examining the quality of long-term receivables to understand the reliability of a firm’s revenue disclosures. Given that our Motorola example was ancient history (the dot.com era of 1998-2000), this month let’s look at an example from just last year: General Motors.

A Current Case Study: GM

Last month I offered three steps to follow when examining long-term financing receivables:

What is the current economic and operating context of the company?
What is the growth in long-term financing receivables relative to revenue growth? If much faster, is this a part of the company’s strategic plan?
What are competitors doing to generate new revenues, and what is the creditworthiness of the customers to which the company is selling?

In General Motors’ case, we are going to evaluate its 2020 revenues by looking at its long-term financing receivables.

Current Economic and Operating Contexts

2020 was the Year of COVID-19. Globally, the virus shut down the economy. This meant massive job losses, and much less demand for transportation.

Those two forces taken together mean that the context for General Motors was less than ideal. If no one is driving anywhere, automobiles are not wearing out as fast. That reduces the demand for autos.

Also, if people’s incomes are lower because they don’t have jobs, they’re more likely to repair the automobiles they have before purchasing a new one. In some cases, they may even forego one good (their automobile) for a cheaper one: public transportation.

In other words, we can expect that GM’s 2020 context included:

Pressure on sales, and an incentive to discount prices to sustain demand;
More extension of credit to customers so that they can afford GM automobiles; and
Creditworthiness of customers to decline.

Growth in Long-term Finance Receivables Versus Revenue

Here are the past 10 years of GM’s disclosures around both “Long-term finance receivables” and “Net sales and revenue”:

Pay attention to the figures highlighted in yellow. In particular, look at the growth in “Total finance receivables” as a percentage of GM’s “Automotive net sales and revenues.”

In 2011, finance receivables were just 6.3 percent of total automotive net sales and revenues. By 2020, that figure ballooned to 55.2 percent. For example, in 2020 total finance receivables were reported as $59,970 million. When divided by $108,673 million of automotive net sales and revenue, that equals 55.2 percent.

As a research pro, you clearly would prefer that this kind of growth is “part of the plan.” If not, then this spells doom for GM, yes? Recall that in our Motorola example for the two year period of 1998 and 1999, the absolute growth of the company’s long-term finance receivables was larger than that of revenues. In other words, all new sales were financed sales, not cash sales.

In GM’s case, the third and fourth highlighted lines, above, show this story. As you can see, in every year for the last 10 (except 2016) finance receivables grew, on an absolute basis, faster than automotive net sales and revenues. The totals are that automotive net sales and revenues shrank by $40,193 million from 2011 through 2020; while finance receivables grew by $50,620 million. Wowza!

This is clearly not an ideal situation. Even if it were a part of GM’s strategy to grow its financing business, you would want the returns for financing to be high, since you are substituting a cash sale with a financed sale. Surely you know that the interest rate spread story 2011-2020 is not a good one. Spreads are low because interest rates are historically low.

What Is the Creditworthiness of GM’s Customers?

Our data above suggest a high-wire act on the part of General Motors — an act that is only sustainable if GM can:

Attract creditworthy customers to purchase its automobiles; and
Maintain the creditworthiness of its customers over time.

If creditworthiness tanks, GM likely does, too. Revenue sanctity is always a strategic issue for a company. No revenues = no business. Thus, GM doesn’t only have pressure to manage its loan-based customers well; it also has pressure on the automotive design team to create compelling products that attract high credit-quality customers. Marketing must also inform creditworthy customers of the GM story. And on and on.

In other words, GM can ill afford any mistakes.

Fortunately, the story here (based on GM’s disclosures) is encouraging. Specifically, the company reports the following credit statistics for customers in its 10-K filing for 2020:

Importantly, these figures show only the 2020 creditworthiness picture, even though it may look like the data go back to 2016. What the above data show are the vintages of loans made to both retail and dealership customers. In other words, there were $555 million of loans made to customers in 2016 where the credit rating is greater than 680 (that is, prime). While the data above are limited to 2020, they are instructive because of the perfect storm economic and operating environment that GM faced due to COVID-19 in 2020.

At a glance we can see that GM has done a good job of maintaining the creditworthiness of its customers. In fact, it looks as if the overwhelming majority of its retail and dealership customers are creditworthy. To make better sense of these figures, I calculated common-size statements for each of the years disclosed (that is “prior” through to 2020, and those customers/dealerships on “revolving” credit):

Here you can see that GM is doing a good job of staying up on the high wire. Most of its loans outstanding are in the hands of creditworthy customers. Whew!

[Let me interrupt this program, for a general financial statement analysis tip. Namely, get creative in your work! The above table does not exist in the GM 10(k). I took the liberty of creating my own “common-size” statement to help me tease out insights. And there are more such statements below.]

What about the percent of customers in each of the top creditworthy customers, and that cuts across retail and dealership customers? Here’s what that looks like:

Above, the most important column is the one furthest to the right. As you can see, over 80 percent of GM’s customers fall into the top two tiers of creditworthiness. We can also see across the vintages that GM has likely minted a higher-quality customer than it was previously. Either that, or the customers of previous vintages have been forced to hold on to their automobiles for longer. This story can also be extracted from the above chart. But take a look at the absolute figures shown in TABLE 2, above. GM seems to be doing OK.

Here is one final set of data to examine:

Here the denominator for every number in Table 5’s common-size figures is the $59,970 total finance receivables shown in 2020. Again, with the data presented in this way, you can see at a glance that GM has a credit portfolio that seems insulated from the wrath of COVID-19 in 2020. It also seems well poised to survive 2021, never mind that its finance receivables are growing much more rapidly than automotive net sales and revenues.

Finally, what about GM’s provision for loan losses relative to the size of its total finance receivables? In 2020 the company set aside $1,978 million against a total portfolio of $59,970, or 3.3 percent. When compared to the size of its < 620 FICO and Tier III & Tier IV customers, the figure is 18.3 percent ($1,978 million ($10,553 million FICO < 620 + ($253 million Tier III + $4 million Tier IV))).

Conclusion

Research pros can never take any figure in financial statements at face value. Even a supposedly simple figure like revenues can be better evaluated by considering a company’s operating and economic context, and dissecting its disclosures around receivables.