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Don't Fear Rising Sales Incentives at General Motors

General Motors (NYSE: GM) seemed to have silenced its doubters just a few weeks ago, when it reported a record Q2 profit. GM even raised its full-year EPS guidance -- despite the expected negative impact of Brexit.

However, fears that GM's profit has peaked have returned in the past two weeks. First, top rival Ford Motor (NYSE: F) issued a disappointing Q2 earnings report. Second, GM reported a sharp jump in incentive spending in July.

Ford executives see tougher times ahead in the U.S. Image source: The Motley Fool.

Fortunately, these concerns are (still) probably overblown. GM has been keeping a very tight lid on inventory for the past year, and the uptick in discounting last month was part of its strategy to proactively clear out some 2016 models before the 2017 versions show up. Additionally, favorable product mix shifts continue to bolster profitability.

Ford warns investors about rising incentives

After General Motors reported its record Q2 performance, Ford seemed poised for a strong earnings report as well. After all, Ford outperformed its Detroit rival during the first quarter.

Instead, Ford reported a year-over-year profit decline, missing analysts' earnings estimates by a wide margin. Ford's management now projects that U.S. auto sales will decline year-over-year in 2016, and it anticipates headwinds in other markets, too. As a result, Ford warned that it is in danger of missing its full-year earnings guidance.

The projected slowdown in U.S. sales -- and an accompanying rise in discounting -- was the most worrisome part of Ford's earnings report. Ford and GM still both generate most of their earnings in the U.S. Anything that imperils their profitability at home could cause significant earnings declines for both companies.

Incentive spending rises at General Motors

Following Ford's warning about rising incentives, GM investors couldn't have been pleased to see sales incentives jump to 14.2% of average transaction prices (ATPs) in the U.S. during the first three and a half weeks of July. By contrast, GM's incentive spending totaled just 10.1% of ATPs in June.

GM rolled out big discounts on 2016 models in early July. Image source: The Motley Fool.

General Motors did note in its July sales press release that the spike in incentive spending came from a big sale that GM ran during the first eight days of July. As a result, incentive spending for the full month was probably lower than the 14.2% figure that was reported, which doesn't include the last week of July.

Furthermore, while other automakers have been leaning heavily on fleet deliveries to keep sales afloat, GM has been pulling back on fleet sales for the past year. In July, just 11.6% of GM's domestic deliveries went to fleet buyers, well below the 20% level GM is targeting for the full year.

Meanwhile, the General's retail sales -- which are typically more profitable -- increased 5% year over year in July. Even with elevated sales incentives, General Motors is probably generating a stronger profit margin than automakers that are selling lots of vehicles to rental car companies.

Finally, a favorable mix shift toward trucks and SUVs will bolster GM's profit. General Motors rolled out big sales incentives on its full-size pickups in early July, helping it to sell 76,544 full-size pickups during the month, outpacing Ford's F-Series sales by nearly 11,000 units. This came after Ford outsold GM in the U.S. full-size pickup market by 4% in the first half of 2016.

Higher incentive spending drove strong full-size truck sales at GM in July. Image source: General Motors.

Since automakers frequently earn $10,000 in profit per full-size truck sold, GM is making plenty of money on these truck sales despite the higher-than-usual incentives.

Additionally, sales of the midsize Chevy Colorado and GMC Canyon trucks continued to surge, rising 29% in July. GM also posted double-digit year-over-year growth for its full-size SUVs: another key profit center.

No cause for concern

As of late July, General Motors executives felt confident enough to not just maintain but to raise the company's full-year earnings guidance, despite offering big sales incentives early in the month. This suggests that GM isn't facing the same headwinds as Ford, perhaps due to differences in the two automakers' U.S. product portfolios.

Looking more closely at GM's July sales results, it appears that two favorable mix shifts -- toward pickups and large SUVs rather than cheaper sedans and toward retail sales rather than less-profitable fleet sales -- will keep GM's profitability near record levels despite the uptick in incentive spending. With shares trading for barely more than 5 times earnings, General Motors doesn't need much profit growth to send the stock higher over time.

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Adam Levine-Weinberg owns shares of General Motors. The Motley Fool owns shares of and recommends Ford. The Motley Fool recommends General Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.