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GM's Big Assumptions


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If there's one thing that investors should have learned as a result of the recent credit crisis, it's the danger of accepting inflated numbers—whether they be home prices or advertising pages—as the norm. Newspapers have to accept that they won't be able to return to the day of fat print budgets, and carmakers will have to adapt to a world where only people who can truly afford a new car will buy one.

But there's a lot of disagreement about what that world will look like. And just how big the future car market will be plays a major role in General Motors' (GM) survival. In fact, as its annual filing with the Securities & Exchange Commission made clear on Mar. 4, GM's auditors have "substantial doubt" about the carmaker's ability to continue as a going concern.

That statement may have been routine business for GM's auditors, but the company's plans to return to viability seem to be based on two pretty big assumptions. The first assumption is that there is a bonanza of pent-up demand on the other side of this downturn. The second is that the rebound will be big enough to service the debt that the company will have as it borrows more from the government.

Betting on a Recovery

For the last decade, "all the tools were there to let the market overheat," says Gary Dilts, senior vice-president for J.D. Power's Global Automotive group. "Everything was geared to do that. Now it's geared to not do that."

Just look at the car market. GM and most other automakers think that the current rate of sales—a dismal 9.1 million annualized selling rate in February—will add up to a flurry of car purchases once the economy recovers. By 2012, GM thinks carmakers will once again start selling 16 million cars a year and that could go as high as 18 million.

Maybe pent-up demand will spring loose a bonanza. But analysts are increasingly thinking that even selling 16 million cars and trucks may be a great year, not the norm. J.D. Power thinks consumers will buy between 14 million and 15 million vehicles a year, Dilts says. Ford Motor (F) market analyst George Pipas says 16 million may "be the high watermark." He could well be right.

A Boom Fueled by Cheap Credit

Let's consider a few facts. For the past 10 years, auto sales soared well over 16 million cars and trucks every year. In 2000, at the height of the dot-com boom and when real estate was surging and credit was easy, Americans bought a record 17.8 million vehicles. That was pretty astonishing growth back then when you consider that annual auto sales only crossed 16 million vehicles in the U.S. in 1999 when stock markets were booming. Other than that, car sales were between 12.3 million and 15.5 million for the entire decade of the 1990s.

At the start of the decade, auto executives figured the car market was around 15 million. That was the rule of thumb. With a strong economy or a pitched sales war that led to price cuts, it could go higher. But 15 million vehicles was the benchmark.

Since 1999, Americans have bought a lot more than 15 million every year. They used home equity loans, easy credit from auto finance firms, cheap lease deals, and huge rebates to buy cars even when the one they had was just a few years old. Some people who once could only afford a used car were buying new rides. All of that inflated the car market by about 1 million vehicles a year, says J.D. Power.

Leases and Rental-Car Sales Fall

Many banks won't even do lease deals anymore. GMAC Financial Services does little if any leasing and GM owns a stake in that lender. The banks that are leasing are using tougher terms, so the monthly payments are higher. And home equity? Let's all bow our heads to the passing of home equity.

Rental-car sales also played a big role in the boom. Before GM, Ford, and Chrysler started to take downsizing their factories seriously, they just sold off their excess production to rental companies. Often, they would lease the car to a rental agency for three months and then take it back. It didn't make them any money, but it propped up sales. J.D. Power says that's another 1 million vehicles a year.

If J.D. Power is right, then the industry sold 2 million cars a year more than it should have over almost an entire decade. That may be right. If 15 million vehicles is the real size of the market, then the extra sales on top of that since 1999 adds up to almost 17 million. That's almost 2 million vehicles a year.

Long Wait for a Bonanza

So what does that mean for pent-up demand? The industry may have to wade through some portion of those extra millions of vehicles that were sold before it starts to see a bonanza. In fact, J.D. Power dropped its near-term forecast by about 1 million cars a year. Dilts says that by 2011, annual sales may only grow to 13 million vehicles. GM has the market at 14 million vehicles and much higher than J.D. Power's forecast going beyond that. If it doesn't hit 16 million in 2012, GM will owe more than $20 billion by then to the government.

Not surprisingly, GM executives and other industry insiders aren't ready to concede that the car market is smaller than we've seen in a decade. Population growth will create more buyers, they say. Every year, 2 million more drivers get a license. And about 12 million cars are scrapped every year. With sales so low, the median age of cars on the road is now almost 10 years old, says Michael DiGiovanni, GM's chief market analyst. "Cars were a bubble like housing," DiGiovanni says. "But that doesn't mean it won't rebound to 16 million cars."

It will have to for GM's sake. The company's recovery plan says that it will renegotiate $27.5 billion in bond debt down to $9 billion. The company also will likely cut a deal to slash $20 billion in cash owed to a union-led retiree health-care fund to $10 billion.

Big Interest Payments

To get there, GM will reduce its current nongovernment debt load of $63 billion down to roughly $35 billion. Then, it will add almost $30 billion in government debt on top, replacing those liabilities with government borrowings almost dollar for dollar.

That means big interest payments siphoning cash and profits. The good news is, GM says all of its cutbacks mean it can make money if consumers buy just 12 million cars a year. The bad news is, they may not buy enough cars for GM to pay back its loans in a reasonable time.

Welch is BusinessWeek's Detroit bureau chief.

David_welch
Welch is a reporter for Bloomberg News and Bloomberg Businessweek in Detroit.

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