BAML analyst John Murphy investigates the recent General Motors Company (NYSE:GM) recall, speculating on what kind of effects it will have on the company.

General Motors

The events surrounding the General Motors recall of 1.6mm vehicles are tragic, but the financial impact to General Motors Company (NYSE:GM) will likely be small. General Motors’ recall reserves appear more than sufficient to cover the cost of repair and potential liabilities. However, the issue will take time to resolve and sentiment on the stock could remain depressed.

General Motors: Unfortunate tragedy, but impact on stock likely limited

The deaths associated with the alleged faulty ignition switch on 1.6mm old General Motors vehicles are a human tragedy. From a financial perspective, the impact to GM is likely small, in our view. General Motors’ recall reserves appear more than sufficient to cover the cost of repair and potential liabilities while the sales impact will likely be negligible based on past recalls, in our view. Furthermore, although GM may choose to pay for costs associated with the alleged faulty ignition switches, the total liability may not even reside at General Motors Company (NYSE:GM), but at the former bankrupt entity though the issue may take time to resolve. Therefore, we believe the ultimate financial impact will be relatively small. Nonetheless, the headlines are depressing sentiment on the stock, and DOJ/congressional investigations are never good news, so the negative impact on the stock may linger temporarily.

Reserves are robust, repairs likely more than covered

General Motors Company (NYSE:GM) reserves about $500 per vehicle wholesaled for recalls and similar costs for the lifetime of a vehicle, which in total equates to about $3bn annually. Total reserves at the end of 2013 stand at about $7.2bn. We’d estimate the cost of the repair at less than $50 per occurrence including labor, so on a base of 1.6mm vehicles the total cost of repairs would be about $80mm, well below existing reserves.

Vehicles no longer sold in US so impact on volume is limited

Historically large recalls have had a temporary impact on volumes for the vehicles impacted, which would be a risk. However, all of the vehicles being investigated in the US so far are no longer being sold including the Chevrolet Cobalt, Pontiac G5, Saturn Ion, Chevrolet HHR, Pontiac Solstice, and Saturn Sky. Furthermore, about half of the volume is from the discontinued brands of Pontiac and Saturn.

Sentiment may take time to recover

Although the basics of the recall and investigation may not have a material impact on the stock in the long run, a DOJ and congressional investigation are never good news. Until the rhetoric eases the negative pressure on the stock may persist. We believe there should be more concern about the soft start to US sales early in 2014 and elevated inventory levels, but even these risks are temporary, in our view, as sales appear poised to accelerate into the key Spring selling season.