Sunday, April 06, 2008

Next Big Catastrophe: Detroit Automakers

For the past 20 years, Honda and Toyota have generated a profit. Ford and GM, meanwhile, haven't made money since 2005, and will lose money again in 2008. When the next full recession hits, I figure it will be the ballgame for these guys. These companies are rated B-, and their debt trades in the middle of this range for most stuff, about 700 bps over Treasuries.

The kicker was that recently Appaloosa Management decided it would not inject the money needed to get Delphi out of bankruptcy, which means GM is left with this big loser, or must kick in more money to get a buyer. Big companies can play games for a long time, for example, GM was paid by Delphi for a loan...with debt.

But there was a happy story in this weekend's Barron's, noting that it should increase to profitability in 2009! What company doesn't anticipate profitability the year after next? Barron's also noted that it is trading at "half its historical multiple of 2.2 times expected 2009 cashflow". Since when has Price-to-[year after next cash flow] a valid multiple?

The next recession, not this thing, but when unemployment hits 7% and such, the US automakers are dead, because their cost base is so much higher than the Japanese, even for cars produced in America. If you are making widgets, and it costs you $2, and your competitor's cost is $1, the equilibrium price will be in the middle, and the game will end only when the high cost company exits. Detroit costs are about 30% higher than Japanese!


Anonymous said...

UAW's goal is for GM/Ford to survive, not to be profitable. But UAW will allow salaries to be cut to competitor levels before they will put themselves out of business. If Detroit makers go bankrupt they'll come back the same but with slightly better cost structure, like the airlines. And Washington will come running to help even if McCain wins, they will subsidize it to the break-even point as long as necessary.

AHWest said...

What worries me is that I attented a panel discussion of auto finance. A rep from Moody's was there, and they use the same techniques to rate auto asset backed securities as mortgage backed securities. Fortunately there hasn't been an auto price bubble so perhaps there's not quite as much downside.

My main fear about otherwise strong companies like Honda is that the US govt uses regulations and socialization of healthcare to narrow their competitive edge vs GM and Ford.