Automakers Running out of Gas

August 23, 2006

Domestic automakers have been in trouble for years now, and their problems remain far from over. Regardless, GM and Ford have become more attractive investments than Toyota and Honda now.

Ford’s (F) announcement to slash production of vehicles by 21% exposes the critical situation that domestic automakers are in. Automakers like Ford and General Motors (GM) have struggled in the wake of lagging consumer demand and hefty cost obligations. Shares of both Ford and GM have leapt ahead on hopes of a turnaround for the industry, but the Ford news shows that the industry remains stuck in neutral.

Ford has already made plans to shut down 14 manufacturing facilities and cut 30,000 jobs. The broader turnaround plan hinges on revamping product lines and cutting costs. Ford has struggled as Japanese automakers Toyota Motor (TM) and Honda Motor (HMC) have increased market share and benefited from lower costs and better response to their products.

Vehicle sales have lagged at Ford and GM as rising gasoline prices drive consumers to fuel efficient or hybrid vehicles. Both Ford and GM were late in entering the market for hybrids, while Honda and Toyota were early pioneers of the innovation, with the Insight and Prius models respectively. GM is known numerous gas guzzlers and doesn’t have the same reputation that Japanese automakers have earned. As gas prices began their climb last year, fuel efficiency came to the forefront for consumers. GM and Ford were forced to resort to gimmicks like “Employee Pricing” to get their vehicles out of lots.

Legacy and material costs have squeezed profits and magnified declining sales. Although lump sum buyouts of employees provide some opportunity to right a sinking ship, they may be too much of a burden to bear. Over the long run, this will likely improve profit margins, but rough seas remain. It is estimated that for each car sold by US carmakers, $1,500 to $2,000 goes towards health and retirement benefits. Material costs including steel have increased over the past few years, further crimping earnings potential.

Bankruptcy fears also loom for the industry in the wake of auto part maker Delphi’s (DPHIQ) recent bankruptcy. Delphi was spun off from GM in 1999, and filed for bankruptcy in October 2005. Delphi faced the same pressures that GM and Ford are dealing with now, and the ultimate outcome for it does not bode well for the automakers.

Daimler Chrysler (DCX) has held up better than the pack, due in part to its exposure to the luxury vehicle segment. The Mercedes unit has helped Daimler Chrysler procure almost $200 billion in sales over the past year. The stock is currently trading at a P/E ratio of 10.7 with a market cap upwards of $50 billion. Only two analysts cover the company – one with a strong buy recommendation, and the other a hold. Daimler Chrysler is the strongest of the Big 3 automakers, but this doesn’t necessarily make it the best investment, since it has the least potential not only for depreciation, but also appreciation.



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