The question of whether General Motors (NYSE:GM) can survive or go out of business will be a matter of the company’s ability to service its debt load. In this aspect, the ability of a company to service its debt boils down to its ability to cover the interest expenses which are usually the results of its indebtedness.
If GM continuously failed to cover the incurred interest expenses for several financial periods, it means that the company is in a dire situation, and it can certainly go out of business or bankrupt. In this case, GM has either carried too much debt or the business environment has deteriorated. To fix it, GM can either revive the business so that more revenue streams can be created or reduce the debt loads by selling some of its assets.
In this article, we will measure GM’s ability to cover its interest expenses from the perspective of the company’s generated profits. Specifically, we will look at GM’s operating income and the adjusted earnings before interest and tax (adjusted-EBIT) with respect to the incurred interest expenses on a quarterly as well as trailing twelve months (TTM) basis.
The analysis of GM’s operating income and adjusted-EBIT with respect to interest expenses gives us the interest coverage ratio or times interest earned ratio. By looking at these ratios over multiple quarters, we can find out how GM’s business has performed over a period of time in terms of its debt-paying capabilities.
Let’s move on!
GM’s Automotive Interest Expense
Before heading off to the ratios, let’s take a quick look at GM’s incurred automotive interest expenses from 2015 to 2020 which are shown in the chart above.
Take note that only the automotive segment interest expense is measured in the chart above and the figures are a direct result of the automotive debt that GM is carrying on its balance sheets. As of 1Q 2020, GM carried about $30 billion of automotive debt according to this article: GM’s automotive debt load.
Based on the chart, GM’s automotive interest expense has been increasing steadily for the past 5 years, surpassing the $200 million levels per quarter in 2019. As of 1Q 2020, GM’s automotive interest expense has slightly decreased from its new high to around $193 million. However, the Q1 2020 result still represents a year on year increase of 7%.
Over the last 5 years, GM’s quarterly automotive interest expense has doubled from around $100 million per quarter in 2015 to nearly $200 million per quarter in 2020. The increase in automotive interest expense has been a direct result of the company’s increasing debt load over the years.
GM’s Automotive Interest Expense (TTM)
The chart above shows GM’s automotive interest expense on a trailing twelve months (TTM) basis.
The TTM chart above clearly shows that GM’s automotive interest expense has been on a rise and reached a new high at $792 million as of 1Q 2020.
GM’s Operating Income
As mentioned, we will look at GM’s debt servicing capability by analyzing the company’s operating income with respect to the interest expense. Therefore, the operating income is an important metric that is worth taking a look at.
In this discussion, I have created the chart above that shows GM’s quarterly operating income over the past 5 years from 2015 to 2020.
On a side note, the operating income is also referred to as the earnings before interest and tax (EBIT) and is a variable that can be extracted from the income statements. While the operating income is measured before accounting for interest and tax expenses, it takes into account of all expenses such as costs of sales, depreciation, R&D and SGA expenses. Therefore, the operating income is a measure of the company’s operating strength by taking into account of all the operating costs of the company.
Of all the quarterly results, GM reported only 1 quarter of negative operating income which occurred in 4Q19. As of 1Q 2020, GM’s operating income of $657 million represents a year over year decrease of nearly 50% compared to the corresponding quarter a year earlier.
The chart above may not tell us much about the trend of the quarterly operating income. As such, we will look at the company’s operating income on a TTM basis which is shown in the next chart.
GM’s Operating Income (TTM)
The chart above represents GM’s operating income on a TTM basis.
This chart clearly shows that GM’s operating income has been on a downtrend since 2017 and reached only $4.9 billion as of 1Q 2020 on a TTM basis. This figure was the 2nd lowest compared to the $4.4 billion reported in 4Q 2018.
The adjusted-EBIT or adjusted earnings before interest and tax is another important variable that was extracted from GM’s quarterly and annual financial filings.
The adjusted-EBIT is similar to EBIT but is adjusted by GM to account for only core-related operating results. According to GM’s financial reports, the adjusted-EBIT is a non-GAAP variable that is used exclusively by the management but can also be used by investors to review GM’s core operating results because it excludes certain items that are not considered part of the core operations such as impairment charges on long-lived assets, exit costs resulting from strategic shifts, costs arising from recall and legal matter as well as currency devaluations.
Other than the items mentioned above, the adjusted-EBIT, similar to EBIT, also excludes the automotive interest and tax expenses as well as interest incomes related to the automotive segment.
In short, the adjusted-EBIT focuses on the company’s core operating strength and is a more refined metric than the EBIT itself.
Coming back to the chart above, GM’s quarterly adjusted-EBIT is in much better shape than the quarterly operating income when certain non-core related items were excluded in the measurement.
As seen from the chart, the adjusted EBIT averaged more than $2 billion per quarter prior to 2020. However, the figure was affected considerably in 2020 when the adjusted EBIT dived to only $1.25 billion in 1Q 2020.
Moreover, it was much worse at only $105 million in 4Q 2019. According to GM, the 4Q 2019 result was badly affected by the employee strike that took place throughout the quarter and had literally stalled the productions in North America.
Again, the quarterly results may not tell us much about the trend. As such, we will resort to the TTM chart which is shown in the next discussion.
GM’s Adjusted-EBIT (TTM)
On a TTM basis, we can clearly see that GM’s adjusted-EBIT has been on a decreasing trend since 2018. The trend dropped drastically in 4Q 2019 and 1Q 2020.
As of 1Q 2020, GM’s adjusted EBIT on a TTM basis was only $7.3 billion which was the lowest from 2016 to 2020.
GM’s Interest Coverage With Respect to Operating Income
Since we have got everything covered in terms of the company’s interest expense, operating income as well as the adjusted-EBIT, we can now proceed to analyzing the interest coverage ratio or times interest earned ratio for GM.
The chart above shows GM’s interest coverage ratio with respect to the discussed operating income from 2015 to 2020.
While the trend may not be that obvious in the chart, we can see that the ratio has weakened considerably since 2018. The ratio has even gone negative in 4Q19 at -2.8 but the ratio has bounced back to a positive number at 3.4 as of 1Q20.
Despite having a positive times interest earned ratio of 3.4 in Q1 2020, the figure was still one of the lowest since 2015.
GM’s Interest Coverage With Respect to Operating Income (TTM)
On a TTM basis, the trend of GM’s interest coverage or times interest earned ratio is clearly visible between 2015 and 2020.
Over the current chart, we can clearly see the downtrend of the ratio between 2015 and 2020. In 2016 and 2017, GM’s interest coverage ratio was averaged around 16 on a TTM basis. However, that figure has slowly declined to only 6.2 as of 1Q 2020, which was one of the lowest over the shown period.
Also, GM’s interest coverage ratio has considerably weakened in 2019 when the ratio dropped below the 10 thresholds for the first time since 2015. The ratio has remained below 10 from 2019 to 2020.
A decreasing times interest earned ratio between 2015 and 2020 implies that GM’s ability to service its debt load has slowly diminished over time and may reach a dangerous level if the ratio keeps decreasing in the near future.
Nevertheless, at 6 times the operating income on a TTM basis, there are still plenty of rooms for GM to cover the respective automotive interest expense with the generated operating profits.
GM’s Interest Coverage With Respect to Adjusted EBIT
The chart above shows GM’s interest coverage ratio with respect to the adjusted EBIT from 2015 to 2020.
On a quarterly basis, the company’s ratio has steadily decreased and hit a new low between 2019 and 2020. As of 1Q 2020, GM’s interest coverage ratio with respect to adjusted EBIT was only 6.5, which was one of the lowest since 2015.
Prior to 2020, GM’s times interest earned ratio with respect to adjusted EBIT of 0.5 reported in 4Q 2019 was the worst over the shown period. The severely low ratio was driven largely by the employee strike which took place during 4Q 2019 and had affected mainly the company’s production in North America.
While the downtrend may not seem that obvious, the ratio has actually averaged around 11 in 2019 which was one of the lowest since 2015.
GM’s Interest Coverage With Respect to Adjusted EBIT (TTM)
Similarly, on a TTM basis, we can clearly see the downtrend of GM’s interest coverage ratio with respect to the adjusted EBIT from 2015 to 2020.
As of Q1 2020, GM’s times interest earned ratio has reached the lowest at only 9.2 times the adjusted EBIT on a TTM basis. The Q1 2020 result represents the lowest for the past 5 years.
Nonetheless, GM’s adjusted EBIT was still able to cover the incurred interest expense more than 9 times on a TTM basis. This ratio implies there are still plenty of rooms left for GM to make the necessary adjustments before the ratio deteriorates further.
Investors need to pay attention to this ratio from time to time so that they can keep track of GM’s debt servicing ability and take action before the ratio deteriorates to a point of no return.
To recap, GM’s automotive interest expense has reached a new high as of 1Q 2020, especially on a TTM basis where the figure has reached as high as $794 million. On a quarterly basis, GM’s interest expense was at $193 million, representing a year on year increase of nearly 7%.
Based on the analysis of GM’s interest coverage ratio and times interest earned ratio, GM’s ability to service its debt load has weakened considerably in recent years. However, the ratios still sit comfortably at a reasonable figure. For instance, on a TTM basis, GM’s interest coverage was more than 6 times the operating income in 1Q 2020.
In terms of adjusted EBIT, GM’s interest coverage was more than 9 times the adjusted EBIT in 1Q 2020 on a TTM basis, giving the company plenty of time to make the necessary adjustment to improve its debt servicing ability.
If the ratio keeps decreasing, GM will most likely go into a dangerous level where the company may not be able to cover the interest expense anymore. Unless the company takes drastic action, it will most likely not survive and will eventually go out of business because of the heavy debt load.
Will GM go out of business? Unlikely. As of this article was published, the company was still pretty safe as seen from the generated operating profits and the adjusted EBIT that still comfortably covered the incurred interest expense multiple times.
References and Credits
1. All financial figures in the charts above were obtained and referenced from the annual and quarterly filings available in GM Investor Relations.
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