"A Going Concern" – The Global Auto Industry

Comments: 1

March 6, 2009

The US auto industry reported February sales and the market continues to weaken. The months saw sales fall 39.4% to just fewer than 670,000 vehicles. The seasonally adjusted annual sale rate dropped to 9.1 million vehicles (Figure 1). That is lower than the 9.8 million rate last month and down from 15.4 million in February 2008.

For the month, GM was the industry loss leader posting a 51% decline. According to GM, retail sales were off 43% and fleet sales off 75%. Fleet sales rose slightly from January as financing improved. Chrysler saw sales fall 49%, however, the company said its retail sales were only off 26% compared to a projected 35% drop for the industry (seems about right). Like GM, fleet sales were off 71%. The improvement in retail sales likely resulted from increased spending on marketing as the company led the industry with incentives. Chrysler offered on average $5,566 per vehicle for the month. GM spent an average of $3,584 and Ford $3,430.

Toyota, Honda and Nissan saw February sales declines of 40%, 38% and 37% respectively. Generally, the Japanes manufacturers do not fleet a large amount of their vehicles and would not be exposed to the contraction in that market segment like the US manufacturers. Their retail sales drop appears consistent with Chrysler's estimates. The Japanese makes also increased incentives in an attempt to move the product. Honda consistently offers the least amount of incentives and averaged $1,249 per vehicle for the month. Nissan and Toyota increased incentive spending to $2,509 and $1,744. Toyota did offer larger than normal incentives and did not have a lot to show for it.

Overall, the market continues to show exceptional weakness. The following analysis attempts to understand the market dynamics going forward.

Figure 1: Seasonally Adjusted Annual Rate of US Vehicle Sales (Source: Automotive New)

At a May 2008 Banker & Insurance Conference, GM’s chief sales analyst presented the conditions of the market as well as the company’s future expectations. The presentation also outlined a few key indicators of a recovery in the automobile market and the greater economy. At the time of the conference, the financial crisis was still four month away. However, the automobile market was getting softer as the price of gas was shooting up to $4/gallon and oil to $150/barrel. Also at the time, the housing market was getting weaker as the housing bubble was in the process of popping and sub-prime mortgage mess was kicking in. Officially, the US economy was not in a recession but that was later shown to be true.

GM’s presentation investigated the last big downturn in auto sales during the 1980 – 1981 recession (Figure 2). The conclusions were, pickup trucks declined early on in the recession and also recovered quicker than typical passenger cars.


Figure 2: GM Analysis Truck Segment Historically Lead Economic Recovery

Also of interest was the relationship between pickup sales and the construction of new homes. During the early 1980s recession, truck sales tracked accurately with housing starts and continued to track housing starts until the time of the presentation. GM believed the current downturn would continue to track accordingly and when new home construction improved so would the auto market, lead by truck sales with traditional cars following (Figure 3).

Figure: GM Analysis Truck Sales and New Home Construction

To see how current market conditions compare to GM’s earlier analysis, fullsize pickups sales data was compiled for the last 13 months ending with February 2009. The pickup truck data included those vehicles likely to be used for construction. This included the Ford F-Series, Dodge Ram, Chevrolet Silverado, GMC Sierra and Toyota Tundra. These vehicles make up close to 100% of the large pickup truck market.

The fullsize truck sales were than compared against the new residential construction data released by the US Department of Commerce in February (See official report for details).

The updated analysis continues to illustrate fullsize pickup truck sales continue to track new home starts very well (Figure 4). However, that relationship continues to be a problem for the industry as housing starts continue to decline each month. The situation becomes more pessimistic when all indications are, housing starts or truck sales do not appear to have bottomed out. February housing data will not be published until the middle of this month but estimates (National Association of Realtors Presentation Feb. 2009) are it will be lower and should track pickup truck sales, which did declined in February. The rate of decline in the housing market does appear to leveling if only slightly.

Figure 4: Updated Analysis Truck Sales and New Home Construction

It is unlikely the new home market will begin to recover anytime soon as the excess inventory continues to clear out. However, the new $111 billion in infrastructure construction spending called out in the American Recovery and Reinvestment Act of 2009 signed into law in February could help spur truck sales. The commercial pickup truck segment could increase from current levels or at least hit bottom as a result of the stimulus. Furthermore, it may not be long lived if the stimulus bill does not gain traction and the banking sector continues to be in crisis.

If September 2008 marks the historic point of the global collapse in auto sales with the fall of Lehman Brothers ,the industry is almost seven months into it this depression. GM’s European Opel division may be the first casualty of the market collapse. GM acknowledged this week Opel is about to run out of liquidity in the coming weeks and is seeking 3.3 billion in aid from European governments.

GM Europe President Carl-Peter Forster said:

"Our balance sheet is weak and we have no reserves. This crisis is too deep to weather on our own."

Opel cut production 50% in the 4th Quarter of last year and when GM released their 1st Quarter production forecast this week, will continue to cut production 50%. Opel’s problems much like GM’s have been ongoing for some time (See Further Reading below). The situation has just reached the point where GM can no long sustain its North American operations and fund another restructuring in Europe. If Opel gets funding, it aims to be profitable by 2011. That I assume depends on how the market recovers. Depending on how aggressively Opel restructures, it could have a lot lower production capacity than it does now. Worldwide, the Opel brand sold 1.5 million vehicles in 2008 with 1.45 million sold in Europe (GM 2008 Global Sales). I anticipate capacity to be reduced to under one million vehicles.

With limited time available before the company becomes insolvent, GM is also pressing the German government for aid including taking a stake in the company. Opel headquartered in Germany employees directly or indirectly 300,000 people in Europe and approximately 25,000 in Germany (See Further Reading below).

GM is now willing to become a minority interest in a restructured Opel. GM Europe, which also includes the Saab brand (that recently filed for bankruptcy protection in Sweden), has accumulated $9.1 billion in losses from 2002 to 2008. There is not sufficient time for GM to seek investment from private sources (or likely interest as shown by SAAB, HUMMER, Saturn, Volvo and even Chrysler’s pending no cash deal to align with Fiat) and with the ongoing economic turmoil, sufficient funds may not be found. The European governments appear to be the only near-term option.

The German government appears on the surface from public statements resistive to a bailout of Opel because of its ties to parent GM. Much like what we saw in the US when GM, Ford and Chrysler sought government aid. I do believe ultimately Germany and other governments will provide the funding and fill the void of private investors. If for nothing more than job protection.

Opel right now probably has a value of zero to private investors because of its financial position and future prospects in an uncertain economy. But let’s assume the company has a reasonable value of about $5 to $7 billion in a good market. Based upon the amount GM is seeking to recapitalize Opel, the company’s interest in Opel should shrink to around 20% to 40% if the money is converted into an equity stake.

Yesterday GM released its much anticipated 2008 annual report. Most of the financials I cover last week (See GM Reports Full Year 2008 Financial Results and Opel Restructuring). However, in the section of the report outlining the potential risk to the future of the company, its independent auditors, Deloitte & Touche LLP had substantial doubts the company could meet its obligations and its viability was a going concern. GM stated in its annual report:

Risks Related to us and our Automotive Business

There is substantial doubt about our ability to continue as a going concern.
Our independent public accounting firm has issued an opinion on our consolidated financial statements that states that the consolidated financial statements were prepared assuming we will continue as a going concern and further states that our recurring losses from operations, stockholders’ deficit and inability to generate sufficient cash flow to meet our obligations and sustain our operations raise substantial doubt about our ability to continue as a going concern. Our plans concerning these matters, including our Viability Plan, are discussed in Note 2 to the accompanying audited consolidated financial statements. Our future is dependent on our ability to execute our Viability Plan successfully or otherwise address these matters. If we fail to do so for any reason, we would not be able to continue as a going concern and could potentially be forced to seek relief through a filing under the U.S. Bankruptcy Code.

However, I contend the entire global industry including manufacturers, the extensive supply chain and dealer body should be placed under a “going concern”. As I have shown in the past few months, the auto companies do not have the readily available cash to weather the continued drop in sales. Earlier this week it was reported, February sales in Japan fell 27.9% from a year ago.

February sales in Europe were only slight better and spurred by a stimulus program to scrap vehicles. According to JD Power Automotive Forecasting Western European car sales were down 18% in February. In January sales were down 27% compared to the prior year. In Europe, estimates by the European Automobile Manufacturer’s trade association ACEA suggest, production will fall 25% in Europe with sales declining 20% in 2009. As early as late last month, the trade group was anticipating production declines of 15% or more (Press Release).

GM is now actively publically seeking a new owner for its Opel operation and their SAAB subsidiary is under bankruptcy protection. Ford is also looking to sell Volvo.

With a near term sales rebound looking less and less likely each month and the auto companies burning cash at a horrific rate, I am just not sure what the industry will look like next month much less next year.

In a recent interview with the German paper Spiegel, Volkswagen CEO Martin Winterkorn was asked his prediction as to which independent automakers will still be around in three years?

Winterkorn stated:

“There will be two Americans, one or two Japanese, one French company, and perhaps one large Chinese company. Daimler and BMW will exist. But so much is in flux at the moment that predictions are very difficult.”

I continue to believe consolidation is necessary to improve the viability of the industry and that includes the terminations of brands and companies. It is time for governments to coordinate a restructuring of the business model prior to recapitalizing the industry. For example does it really make sense for the US government to aid both GM and Chrysler and end up with three weak companies including Ford or for France to bailout both Renault and PSA? Does the market need both Opel and VW or BMW and Mercedes-Benz? Is there really a demand in the market for 10 Japanese manufacturers competing in the same markets? Is there really that much of a real difference to the consumer between a midsized Toyota Camry, Hyundai Sonata, Nissan Altima, Honda Accord, and the seven or eight vehicles offered by the US manufacturers in that segment? The consumer is given many choices but for the most part the functionality is identical.

Competition and free markets of course are valid arguments and it has certainly driven down the cost of vehicles. Competition has also reduced industry operating margins in a good year to 3% to 5%. The entire industry with few exceptions was running on fumes prior to the collapse and in an environment with little room for error. This environment also reduced innovation and risk taking because good intentions could quickly lead to sharp losses. For these reasons the time is now ripe to dynamite and rebuild the global automotive landscape. The automotive industry is a capital intensive business with high opportuinity costs and will become more so as governments demand more environmentally friendly but expensive vehicles and the economics of scales will not be the same in a much smaller global market. In today's economic climate, the auto business is a failed business model.

I will finish with this. How many commercial aircraft manufacturers are out there?


Further Reading:

Merkel Critical of GM Bailout, Spiegel, March 4, 2009

Berlin Has Doubts About Opel's Rescue Plan, Spiegel, March 3, 2009

The Auto Industry Crisis 'Is Truly Brutal', Spiegel, March 2, 2009

The Sexing-Up of Opel, Business Week, October 1, 2001

GM's Turnaround in Europe, November 30, 2006


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Mon Mar 09, 2009 4:49 pm
Name: haypops | Comment: Thanks for the excellent anaysis.

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