From a pre-junk bond demotion piece on GM, sent to me by Robert Blumen:
GM reached a watershed in its four-decade decline in market share. After losing two percentage points of share over the past year to log in at 25.6%, GM has reached the point at which it actually consumes more cash than it brings in making cars, for the first time since the early ’90s. GM, once the world’s premier auto maker, is now cash-flow-negative. That’s a game changer. Without growth, GM’s strategy of simply trying to keep its factories humming and squeaking by until its legacy costs start to diminish is no longer tenable. If market share continues to slip, its losses will rapidly balloon.
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“It’s difficult for us to see, if volumes and share continue to fall, how they’re going to get the significant cost cuts necessary to stabilize cash flows,” says Mark A. Oline, an analyst at the Fitch Ratings service, which has GM debt at a BBB- rating, one notch above junk, with a “negative” outlook. “Having that kind of cash drain is unsustainable over the long term.”
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In a March report, Merrill Lynch estimated that with a 24% share and the current annual U.S. auto sales rate of 16.9 million vehicles, GM would bleed $2.4 billion in cash per year. If share plummeted to 20%, the cash burn would be $4.5 billion a year. Merrill analyst John A. Casesa estimates GM can last five years before it hits a liquidity crisis. “We believe that 25% market share is the threshold,” Casesa says. “If GM falls below that, things get ugly fast.”
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First of all, the reason of the market share plummet is in the downswing of the US economy. The trade cycle usually takes 12 years for the up and down movements of the economy. Therefore, it is around 3-4 years for the US economy to fall deeper into the recession.
The estimation by John A. Casesa that GM can last five years before it hits a liquidity crisis gives plenty time for the company to recover after recession. Appropriate actions such as cost cut on non-profitable projects, concentraining on the core activities and looking for ways GM can send some of their work to freelancers will help GM to survive the recession and even to claim all the losses back when the economy starts to rise in appoximately 2 – 3 year time period.
It might be, however the thruth is that US car manufacturers are losing ground to others (especially the Japanese). The US companies (and EU ones) are notoriously inefficient and have stopped making profit on selling cars for a long time.
Let’s face it. What is GM core activity, making cars or lending money? Or let me rephrase it, which division is losing money and which one is actually making money?
GM is losing market share b/c they are too levered to selling SUV’s, which are increasingly losing mrkt. share to more fuel effecient vehicles (i.e. Japanese vehicles.) GM is losing money b/c the legacy costs (which the Japanese do not have) is close to $2000 a car. To re-iterate Bas’s point, GM sells cars in order to finance them. Spin off GMAC & you have an outdated, ineffecient manufacturer with too many costs. A recession is not the problem with GM.
You also have a “debt” to retirees that has to be settled. If you remember some otherwise quite sound companies that one division had an asbestos problem (from decades earlier), they went to insolvency quickly.
GM requires a large and steady market (share is less important if the market grows) for autos to be profitable enough to pay today’s bills and yesterday’s promises. They also have to employ people in the regulatory environment of the USA.
What did GM do wrong? There were some mistakes – assuming they would sell a large number of cars (e.g. through maintaining a market share). But the USD going from 120 to 80, having Oil bounce around (GM might make a hybrid, but would anyone buy it, and how much profit per unit, or would it be another loss leader?).
GM and F have problems, but I’ve pointed out before that the market distortions caused by governments benefit some (WMT and MSFT) but hurt others (GM, F). This not the market working, no more than randomly spraying herbicide or fertilizer through a forest is a natural ecology.
And there is and will be real pain for real people. Economics ought to be the servant of man, not man the servant of economics. Austrians are the most faithful servants because they declare what is, not what the master wants to hear.
Guess what? According to most consumer analysis, only Honda and Toyota make cars that are dependable.
And today, lost time due to malfunctioning vehicles is highly costly.
GM and F need to make cars that don’t break down so much!
One may spend a lot of time talking about union
contracts, healthcare costs, government regula-tions, oil prices and incentives. The customer
does not care, he want a reliable product, good
gas mileage and safety.
I have owned two GM cars and neither one offered any of these attributes. Since then I have owned VWs and Toyotas and I will never again buy GM.
How about talking more about how to make a solid product and a lot less about what financial tricks
might be useful to assure profit and survival?
High costs are not “financial tricks”. Losing market share to the Japanese is an inherent criticsm of the way GM & F make their products. GM & F debt being downgraded is also not a “financial trick”; these companies borrow money on a daily basis, a bad debt rating increses their cost of capital. An increased cost of capital increases the price of their product, which is inferior to the Japanese manufacturers.
While I agree government intervention distorts the economy, the problems GM & F face are largely of their own bad decisions. Incompotent, rent seeking management & greedy, power hungry (and rent seeking) unions/employees (in the manufacturing divisions, not in the financing arms) lead to the downfall of U.S. auto makers. Also, dollar weakness is not as signficant to the U.S. auto makers, b/c the majority of revenues are derived from the U.S. (also a lower dollar would mean they could repatriate foreign profits and buy more dollars, which would increase revenues.)
I think y’all should have a little compassion and vote for the Feds to subsidize GM until they can figure out how to make automobiles.
– Dewaine
One of the commenters has questioned my use of the words “financial tricks”. I therefore need to explain my use of the term financial trick and to point out why such tricks are not helpful in making a company profitable. An example of a financial trick is the offer of a cash rebate and making that rebate’s size proportional to the difficulty of selling a given model. A good company builds cars which require no such incentive and which sell on account of their reliability, economy and safety. Low APR’s are another trick. This one is based upon artificially low interest rates combined with an exaggerated MPR, which makes it LOOK like the buyer is getting a “steal”. There are many other
tricks which are used. They are invented by accounting, sales and advertising departments and deserve to be exposed in a Mises article written by an expert familiar with the ways of the car business. All these tricks constitute a way to make and sell a poor product and to avoid proper deference to the engineer and to good engineering principles. They are also an insult to Austrian economic theory.
Business is business; and if US auto-makers cannot produce quality products efficiently, then they should exit the industry–isn’t that what the capitalist system is all about?
Wait til the Japs have that 100% market-share; you will wish you could buy a ford or a gmc vehicle when the average toyota sells for $50K.
G. Rohringer wrote: “…A good company builds cars which require no such incentive and which sell on account of their reliability, economy and safety. Low APR’s are another trick. This one is based upon artificially low interest rates combined with an exaggerated MPR, which makes it LOOK like the buyer is getting a “steal”. There are many other tricks which are used. They are invented by accounting, sales and advertising departments and deserve to be exposed in a Mises article written by an expert familiar with the ways of the car business. All these tricks constitute a way to make and sell a poor product and to avoid proper deference to the engineer and to good engineering principles. They are also an insult to Austrian economic theory.”
Mises, in Human Action addresses the issue of marketing techniques in a free market. His position, if I am not mistaken, is that as always, the consumer dictates the behavior of the entrepreneur. If this marketing approach is an insult to anyone, it would be an insult to the consumer. But apparently, this marketing works, so instead of being an insult, it is merely a reflection of the wants and attitudes of the consumer. Some want a high quality and reliable foreign car; others want a cheap domestic on easy credit. Ford could just lower the price of its inferior cars, but the consumer demands the price be packaged as it is. No biggie.
I have been listening to the “pundits” and get a real kick out of folks that say “who could have seen it coming?” Well, just about anyone doing a fundamental analysis would have seen it coming. This company is a “dead man walking.”
Free cash flow from 2002 through 2004 was negative 4.8 BILLION.
From 2000 to 2004 revenues grew 1.2% (not 12%, 1.2%) and income shrank 11% on an annualized basis.
The company’s net worth was shrinking.
Return on assets has averaged 0.7% (not 7%, 0.7%) over this time.
Their INTEREST PAYMENTS took up 48% of their operating cash flow before interest. Let’s restate – EBIT was 13.1 Billion, the “I” is 12 Billion. It’s a KINDNESS that their debt wasn’t considered JUNK a long time ago.
Three consecutive years of Inventories/Assets climbing (5.3%, 5.9%, 6.3%).
It would take them NINE YEARS of current operating cash flow to pay off their CURRENT LIABILITIES. HAH!
So everyone was shocked when they warned about earnings? Only because they hadn’t looked at financials. The trouble has been brewing for years.
Aside from “legacy costs” and their contribution, http://www.safehaven.com/article-3051.htm, the three big problems are product, brand management, and attitude. Inferior product design, multiple vehicles identical except for body cladding, poor quality relative to the competition, and a dependence on techno-tricks like “OnStar” rather than a desirable vehicle. Ouch. Next we have a marketing budget spread over twice as many divisions and more than three times as many models as most of their competitors. Wait a second … which one is their “sporty” brand, again? Which is “second-tier luxury?” Isn’t Oldsmobile the “import-fighter?” Oh no, that’s Saturn’s role now. Get the point???? Lastly, it’s about attitude. Giving the employees little “25%” lapel pins won’t do the job, folks. No one at GM today was alive the last time GM had a market share this low, and it really seems like they don’t believe it can happen to them … but it has.
Asians have lower labour costs (Japan I’m not so sure), abundant capital (at dramatically lower spreads to libor), knowledge, technology etc and a far less regulatory environment. The historical advantage the British, Europeans then Americans had has gone, period. As division of labour intensifies things will change, all power to the consumer. Look at the quality of vehicle the consumer gets, even at the low end. It would put a 1950s Rolls Royce to shame (minus the prestige of course). On an anecdotal level, anyone who has lived in Japan and seen them at work will realise they have a very different approach which suits some processes better than others. I would suggest car manufacturing would be one. They are obsessed with process and iterative improvements, and have a saying ‘senri no michi mo ippo kara’ … Rover is over, GM and F in current form unless they adapt will be too, it’s just a question of time.
A clarification on what a “financial trick” is. Loading up on debt and buying back shares in order to raise EPS, is a “financial trick”. Using debt to lower your cost of capital is a “financial trick”. Although these tactics, and others, are useful at times, when over used they will typically sink a company. Furthermore, GM is not really in the business of selling cars anymore. GM uses cars as means to loan money, take a loss on the cars & make a profit on the loan. This worked when the Fed. was keeping rates at terribly low rates, but the margin of this strategy are becoming too slim. Bill R. has a very accurate analysis of the problem; the Street has millions of dollars on thousands of pages and still couldn’t give an accurate analysis.
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