Running on Empty in Detroit


By Scott Sprinzen and Robert Schulz, CFA General Motors (GM

; S&P credit rating BB-) and Ford Motor (F

; BB+) are facing operational and financial challenges in North America as never before (see BW, 12/12/05, "What If GM Did Go Bankrupt..."). Even though industry sales have been broadly favorable this year, these companies' market shares have eroded significantly, and sales of their most profitable products have plummeted.

In contrast, the Chrysler unit of DaimlerChrysler (DCX

; BBB) is faring better in North America for now, based largely on its extensive earlier restructuring and on the success of its new products. Also, some Japanese and Korean auto makers continue to gain market share in the U.S., and their financial performance reflects these gains. For example, ratings on Hyundai Motor and Kia Motors were recently raised to BBB-.

Many factors do not bode well for demand in 2006, among them the still-high gasoline prices, rising interest rates, weakening consumer confidence, lengthening auto-loan terms, and declining off-lease volume. Fall sales volumes have been very weak after the strong summer sales resulting from the "employee discount" incentive pricing programs.

These programs were not much more costly than previous incentive pricing plans, and the programs roiled the market, especially during June and July. But demand has weakened since then, especially when considering how these programs "pulled forward" sales into the summer.

MARKET-SHARE SHIFTS. Industry sales were up 1.2% during the first 10 months of 2005, vs. the same period in 2004, and U.S. new-vehicle sales should total about 17 million vehicles for the full year. But the year-end sales trend heading into 2006 is likely to be weaker than full-year 2005's volume would suggest, calling into question how successfully Ford and GM will be able to move from the popular employee-pricing plans to a "value pricing" approach, as they hope to.

There is the risk that, in the face of weakening sales, these companies will simply return to the heavy incentives of the past few years.

Behind solid 2005 industry sales volumes, individual auto-maker sales volumes and profitability are much more varied. GM's and Ford's market shares have been slipping in recent years. This trend continued in 2005 and even accelerated in the fall. GM's share through the first 10 months was 26.5%, down from 27.8% in the same period in 2004. But in October, 2005, alone, it was 22.2%, down from 25.7% in October, 2004.

Meanwhile, Toyota's (TM) U.S. market share has been climbing steadily in recent years. For the 10 months ended October, 2005, Toyota's market share of U.S. light-vehicle sales was 13.2%, up from 12.2% in 2004; that figure reached 15.1% in October alone. Of the three large Japanese auto makers, Nissan and Toyota have gained noticeable market share in recent years; Honda's (HMC) share has been fairly flat, although it was up in October, 2005, from October, 2004. The combined share for Hyundai and Kia was 4.4% for the first 10 months of 2005 -- still low -- but their penetration has grown steadily since 2000. The extent of further market-share shifts in 2006 is unknown, but Standard & Poor's Ratings Services expects recent trends to continue.

CROSSOVER COMPETITION. Perhaps the greatest concern going into 2006 is the challenges that GM and Ford face with the accelerated decline in SUV sales, from which GM and Ford have derived a highly disproportionate share of their profits. The well-publicized shift in consumer preferences away from SUVs, due to taste shifts, substitutes, and gas prices, is now indisputable. What constitutes a sustainable level of SUV demand is now the more relevant question.

For the 10 months of 2005, crossover utility vehicle (CUV) sales were up 15.9%, while SUV sales were down 12.7%. CUVs are proving to be formidable substitutes to SUVs, as they are often built on a car-based platform and have comparable functionality and typically better fuel economy.

The growth in CUV sales is expected to continue in 2006, and sales of crossovers are fluctuating around 50% or more of the combined CUV/SUV market (52.7% CUV vs. 47.3% SUV in October, 2005). Most auto makers now offer CUVs and are striving to increase their presence, but auto makers will be limited in their ability to do so in the near term. The major Japanese auto makers have about a 37% share of this market; GM and Ford have only about 16% each. GM plans to double its CUV lineup by 2009 (CUVs make up about 8% of GM's sales now), whereas CUVs represented about 14% of Toyota's total sales for the first 10 months of 2005.

HYBRID FOCUS. Sales of full-size pickups -- up 0.2% for the first 10 months of 2005 -- had been one of the relative bright spots for most of the year. We believe the pickup segment should continue to hold up better than the SUV segment because of pickups' intrinsic functionality, but there are signs that the full-size pickup segment could also face some pressure in 2006.

October full-size pickup sales were alarming, down 33.3% year-over-year. Non-U.S. competition is increasing in this segment, albeit off a small base. Nissan and Toyota now offer full-size pickups, although the combined share in the segment for GM, Ford, and Chrysler is still very high (88.7% in October), but below the 91.7% for the first 10 months of this year.

Hybrid vehicles will remain a focus in 2006. Despite the favorable price differential between hybrids and traditional gas-powered vehicles, hybrid manufacturers need to improve their profitability because their manufacturing costs are also higher. Sales of Toyota's Prius have more than doubled since 2004, climbing to almost 25% of the sales levels of the Camry for the first 10 months of 2005. But even Toyota has said that costs need to be cut from its hybrid manufacturing to increase profitability, and we do not view rising hybrid sales volumes as a significant rating factor in 2006 for any auto maker.

COST CONCERNS. The decline in market share by GM and Ford has exacerbated a long-standing need to restructure a cost base that is capable of supporting market-share levels that are unlikely to be regained anytime soon. We expect GM and Ford to address the following key cost issues during 2006 and beyond, but all-in restructuring costs could well exceed the resulting savings during 2006.

Idle capacity and surplus manpower: It is uncertain how much rationalization can be accomplished under their respective existing labor contracts, which do not expire until September, 2007. In any case, significant changes in 2006 are likely to require large charges to earnings and commensurate cash payments;

High medical inflation: GM's now-approved agreement with the United Auto Workers represents progress in reducing health-care costs, although cash savings will not be realized until after the next two years. We expect the UAW to grant Ford and Chrysler equivalent concessions. But an important question is whether the UAW will be willing to revisit health-care issues in the 2007 contract negotiations;

Financially weak supply base: In 2006, domestic auto makers will be less able to rely on supplier price cuts as part of their cost-reduction efforts. GM will remain deeply involved in the Delphi bankruptcy, and Delphi's reorganization will likely be costly for GM. Ford will be working to restructure its former supplier, Visteon (VC), although the costs are not expected to be as substantial as those facing GM from Delphi; and

Long-range funding capabilities, and economics, of finance operations: GM and General Motors Acceptance Corp. are actively addressing this issue by attempting to separate the ratings on the two companies through GM's selling a controlling interest in GMAC. Ford has not expressed any interest in restructuring its relationship with Ford Motor Credit Co. Ford Credit has completed two sizable public term debt issuances since the May downgrade. The funding cost competitiveness of captive finance companies will need to be addressed eventually, if not absolutely in 2006.

We believe GM's and Ford's liquidity positions and those of their respective captive finance operations will remain a relative bright spot going into 2006. For example, both companies ended the third quarter with substantial parent-level cash relative to near-term requirements. Still, cash-generation prospects in 2006 for both Ford and GM are crucial factors to watch.

Sprinzen and Schultz are credit analysts following automobile manufacturers for Standard & Poor's Ratings Services


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