Red Ink Warning – The Auto Slump is Global Including the Imminent Fallout

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December 24, 2008

For months now I have been discussing the pending failure of the US automotive companies: GM, Ford and Chrysler. Just last week one chapter of that drama was put to rest when the US government agreed to make bridge loans available to GM and Chrysler to prevent an outright collapse of both companies. These companies are not alone as the whole industry struggles as the worst economic recession since the 1930s unfolds, driven by the collapse of the US market.

Japanese manufacturers because of their reliance on the US market have been adversely impacted as the overall market continues to drop on average about 30% each month since October. This has caused Japanese companies to cut export production and jobs in Japan on top of cuts in the US. Vehicle shipments from Japan to the United States were down 0.74% to 1.8 million vehicles, and shipments to the European Union were down 8.0% to 697,120 through October.

Toyota announced it will to layoff 6,000 workers in the fiscal year ending March 31, 2009. Nissan, Mazda, Mitsubishi, Subaru, Suzuki and Honda also announced production cut backs that will trim an additional 6,000 worker (Figure 1). It should be noted most of the job cuts impact contract workers. Japanese law was changed a few years ago that would allow them to hire temporary workers. This should give them tremendous flexibility during market downturns such as they currently are experiencing and reduced the fix cost burden of guaranteed life time employment.

Manufacturer Job Cuts Production Cuts
Toyota 6,000 953,000
Nissan 1,500 272,000
Mazda 1,300 48,000
Mitsubishi 1,100 110,000
Subaru 800 60,000
Honda 760 141,000
Suzuki 600 246,000
Total 12,060 1,830,000

Figure 1: Japan Job and Production Cuts (Source Automotive News)

This comes at a time when total industry production in the US is planned to be reduced by approximately 39% in the 1st Quarter of 2009 (Figure 2). At Toyota, Nissan and Honda, this will equal about 100,000 less vehicles produced by each compared to 2008.

Manufacturer % Change in Q1 Production
GM -52%
Ford -38%
Chrysler -51%
Honda -21%
Toyota -28%
Nissan -28%
Other -32%
Total -39%

 Figure 2: US Production Cuts (Source Automotive News)

In response to the deteriorating economic conditions, Japanese vehicle manufacturers have also been adjusting their financial forecast for the rest of their fiscal year. These forecasts must also be considered in light of a recession in the Japanese home market and a continued weakness there in auto sales.

This past week Toyota announced (presentation, release) it expects an operating loss of 150 billion yen ($1.7 billion) for the year ending March 31. The announcement came on top of the company already reducing its operating profit forecast by 1 trillion yen to 600 billion yen last month. To put this into perspective the company made a record profit of 2.27 trillion yen last year. This would be the first loss for the company in 71 years.

Toyota President, Katsuaki Watanabe said the company will postpone all projects to expand capacity, move 16 of its 75 global assembly lines to a single shift, raised the possibility of reducing the dividend, and reduce R&D spending to improving short-term profitability.

Last week, Honda announced it expects operating profit to fall 81.1% to 180.0 billion yen ($2 billion) in the fiscal year ending March 31. The revised forecast after the company adjusted its estimates after an earlier downgrade in which Honda said operating profit would fall 67.3 percent. The sharp declines in the US market as well as the strength of the yen were largely to blame.

In October, Nissan announced it expected operating profit to fall 65.9% to 270 billion yen ($2.62 billion), with net income declining 66.8% to 160 billion yen ($1.55 billion). The company has not released additional guidance but it is anticipated any forecast revisions will be in line with those released by Toyota and Honda. It is my expectations it should be worse reflecting sharper sales declines in the US.

The European market is also not healthy as sales dropped over 25% in the month of November. In the same month, the US market fell 37%. Japanese companies are not over exposed or reliant on this market as the US, however, the three big Japanese auto companies saw their sales drop about 15% each (Figure 3). Many of the European car manufacturers are not exposed to the US market besides luxury makes Daimler, BMW and to a lesser extent VW. However, the European market is crowded and the companies historically endure razor thin margin. As Europe struggles with a recession and the manufacturers struggle with sharp sales decreases, a shake-up in the industry should be anticipated.

Fiat CEO Sergio Marchionne recently told the Rome daily La Repubblica:

"The auto sector has the obligation to find a new type of management that will bring about consolidation within the next 24 months."

He also told Automotive News in an interview:

"…the only way for companies to survive is if they make more than 5.5 million cars a year."

To frame Marchionne's comments, Fiat sold 2.2 million vehicles in 2007. In response to the market conditions, the company has temporarily closed most of its Italian plants for a month, laying off nearly 50,000 workers. The shutdowns through mid January affect 14 of the company's 20 Italian plants, and 48,000 production workers out of its nearly 80,000 Italian work force.

In light of Marchionne’s statements, the rumors of an alliance between Fiat and French car maker PSA/Peugeot-Citroen began to circulate. Last year, the two companies produced 6.2 million vehicles including established joint ventures producing minivans and commercial vehicles. A merger or alliance between Fiat-PSA would also create the world's fourth-biggest automaker by production along with VW and Renault-Nissan after Toyota, GM and Ford.

Neither manufacturer has a huge presence in North America but both are well established in South America. A tie-up could lead to capacity rationalization in Europe and South America including greater economics of scale because of product overlap and combined strength to grow in emerging markets such as Russia, China and India. For example Fiat has struggled in China and yet PSA has done well.

Nov. 08 Nov. 07 percent 11 mos. 08 11 mos. 07 percent

2008 2007 change 2008 2007 change
VOLKSWAGEN AG 213,196 258,101 -17.4% 2,813,939 2,940,074 -4.3%
PSA GROUP 114,374 156,566 -26.9% 1,749,034 1,921,328 -9.0%
FORD MOTOR CO. 96,053 119,399 -19.6% 1,358,670 1,457,891 -6.8%
GENERAL MOTORS 76,383 122,158 -37.5% 1,309,874 1,518,028 -13.7%
RENAULT 89,202 114,046 -21.8% 1,213,695 1,282,077 -5.3%
FIAT GROUP 75,871 99,596 -23.8% 1,108,880 1,165,937 -4.9%
BMW GROUP 50,801 73,516 -30.9% 764,442 779,983 -2.0%
DAIMLER AG 53,826 71,285 -24.5% 740,045 784,767 -5.7%
TOYOTA MOTOR 43,541 65,682 -33.7% 732,397 863,615 -15.2%
NISSAN 20,635 26,677 -22.6% 319,810 290,591 10.1%
HYUNDAI 20,219 23,502 -14.0% 254,496 277,520 -8.3%
HONDA 14,467 22,030 -34.3% 247,473 294,393 -15.9%
SUZUKI 15,634 22,429 -30.3% 237,751 265,131 -10.3%
MAZDA 13,892 18,635 -25.5% 233,493 225,462 3.6%
KIA 15,689 22,510 -30.3% 223,151 231,913 -3.8%
MITSUBISHI 7,532 11,092 -32.1% 113,681 132,852 -14.4%
JAGUAR LAND ROVER 5,374 9,442 -43.1% 100,901 127,110 -20.6%
CHRYSLER LLC 3,946 8,710 -54.7% 88,387 110,305 -19.9%
OTHER 1,902 10,783 -82.4% 178,138 165,935 7.4%
TOTAL 932,537 1,256,159 -25.8% 13,788,256 14,834,912 -7.1%

Figure 3: European November Registrations (Source: Automotive News)

These are very uncertain times in the industry as a whole, not just for GM, Ford and Chrysler. It is expected that almost every auto company will be reporting significant losses. The biggest unknown will be the greater economy and if there will be any recovery soon. Because of the industry's high fixed cost, manufacturers are not able to turn on a dime and restructure in months if sales level remain depressed for an extended period of time.  Many many of these companies were not in the best of health going into the downturn. Even Toyota anticipates a large loss, however, with its large cash reserves it should have some breathing room. It is more likely than not, there will be a lot of pressure for the industry to consolidate quickly and likely encouraged and financed by government.  

How this crisis shakes out on the manufacturing level is open for debate. Some manufacturers may merge or acquire and some may just cease. My imminent fear at the moment is with the supply chain. With the large production cuts planned, and balance sheets already built on wafer thin profit margins, it may not even be possible for them to cut overhead enough to remain viable. The Tier 1 supply chain is also reliant on small job shops for components and tool and die work. It is very unlikely these "under the radar" small companies can weather a long downturn without just turning off the lights. In summary, the future of the whole industry certainly appears to be very bleak and I do not see any reasonable way a large shakeup is avoidable.

Further Reading:

Who will survive the auto crisis?, Automotive News Europe, 2008

Entire contents © 2008 The Automotive Lyceum All Rights Reserved



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