The Industry's Recovery: The Devil is in the Details

...I'll cheer when the glass is half full...

The media claims the auto industry as a bright spot in our recovery. If this is good news ... well, read on.

First, sales remain well below peak; we will close out the year as a whole with less than 13 million sales, against a peak SAAR [industry jargon: seasonally adjusted annual rate] of 17 million. So we're still down 24%. Nevertheless, the glass is at least half full, because that's 30% better than the sub-10 million unit level of late 2008-early 2009.

That story is grimmer when we examine the value of motor vehicle and parts shipments; they are still  down a full 33%. But again, at $30 billion shipments are still up 30% from their nadir.

 

Quarterly data from the FRED database of the Federal Reserve Bank of St. Louis. Click graphs to enlarge.

Well, then there's employment. That's up, by about 80,000 in retail and 90,000 in manufacturing. Given the abysmal state of our job market that's something for which we should be thankful. But again, it's from a really, really low base. Well into 2007 manufacturing employed over 1.0 million; compared to January 2007, at nadir the industry had lost 400,000 jobs. Retail saw less of a drop in percentage terms, about 15%, but compared to January 2007, in absolute terms employment at the nadir at dealerships shrank by about 246,000 and parts retailers by 58,000. If we combine the two, January 2007 employment was 2.94 million; the nadir was 2.25 million. Today (Nov 2011) we're at 2.40 million.

Generated by Smitka from BLS data. Click graphs to enlarge.

In the auto sector, retail and manufacturing, we've added 150,000 jobs. Not bad. But we were down 680,000. So at +22% we've not even regained a quarter of what we lost. It's not that things could be worse; things have been much worse.

I'll cheer when the glass is half full.

Mike Smitka
Professor of Economics, Washington and Lee University
Judge, Automotive News PACE "Supplier of the Year" competition

The Politics of the GM-Chrysler Bankruptcies

By David Ruggles

During the recent Republican debate held in Mitt Romney’s home state of Michigan, the presidential hopeful was asked about the “rescue” of General Motors and Chrysler. The premise of the moderator’s question was that since the automakers are now doing well, did Romney “regret his opposition to the rescue?” Romney answered, “The government finally followed my advice,” referencing his November 2008 op-ed in The New York Times entitled, “Let Detroit Go Bankrupt.” [Click to read the full article.]

Despite the inflammatory headline, Romney’s article was temperate and well-reasoned. Some readers might have assumed that the “bankruptcy” Romney recommended was a Chapter 7 liquidation, but that was not the case. The piece was written in the context of events of the day, in particular the Detroit Three CEOs appearing before Congress to request a “bailout.” The initial request was for $25 billion in loans or loan guarantees. That appeal later grew to $35 billion, while the total investment necessary to do the job, which has largely been repaid or secured with stock, ballooned to $81 billion.

In his op-ed, Romney stated that it would be better if the two companies in question, GM and Chrysler, were allowed to go through a “managed, pre-structured bankruptcy to allow them to restructure themselves.” Without such a restructuring, but with a “bailout,” Romney argued, the companies would continue on their current unsustainable path and would ultimately have to liquidate. “But don’t ask Washington to give shareholders and bondholders a free pass — they bet on management and they lost,” Romney said in his piece.

Reached by telephone for this column, Steve Rattner, former chief of the Automotive Task Force, called Romney’s 2008 piece “prescient.” He praises Romney’s op-ed as “95% correct.” According to Rattner, the “Romney plan” was followed almost to the letter. The exception: there was “no debtor-in-possession financing available through private lenders, requiring the U.S. Treasury to fill that role,” he said. (Remember the financial system meltdown of 2008-9 – see the note at the bottom.)

After the “government finally took my advice” comment, though, Romney should have left it there. The Democrats seem to be trying to mischaracterize Romney’s stated position in the New York Times article by applying “liquidation” bankruptcy to Romney’s headline, instead of the reorganization he clearly recommended in the body of the column.

Even more confusing is that Romney himself currently seems to be mischaracterizing his own original position. Bloomberg writes: "In Michigan after Wednesday's Republican candidate debate, Mitt Romney defended his opposition to the government bailout that saved jobs in the tens of thousands at GM and Chrysler. (Again, see the note.) According to Romney, instead of asking the government to intervene, the companies should have entered into private sector bankruptcies immediately.”

Never one to waste an opportunity, former Michigan Gov. Jennifer Granholm, a Democrat, said in an interview with Bloomberg that “Romney's view was ‘a knife in the back’ to his home state."

Rattner, too, is puzzled. “I can’t understand how Romney can go from being so out in front of the auto company reorganizations to disavowing his almost perfect original position. In fact, GM CEO Rick Wagoner stubbornly refused to consider Chapter 11 bankruptcy for GM and had to be removed for the reorganization to go forward.”

By the time Pres. Barack Obama was inaugurated, the Bush administration had already advanced $17.4 billion in “bridge loans” from the Troubled Asset Relief Program to the two ailing automakers. Congress had turned down a “bailout” package despite Vice Pres. Dick Cheney admonishing his fellow Republicans, “Do you want to be known as the party of Hoover forever?”

Perhaps Romney is criticizing the Bush administration for the “bridge loans,” but last anyone checked, George W. Bush is not running for President again.

What is clear is that the rescue of the auto industry will be a hot topic in the upcoming 2012 elections. The President and the Democrats will be taking credit for what so far seems to be a good move, despite flaws in the “rescue’s” execution. The Republicans seem determined to claim that the “rescue” was a “bailout” and shouldn’t have been done.

In Republican frontrunner Romney’s case, he seems to be having a difficult time making up his mind what he thinks. His camp did not respond to a request for clarification of his position in advance of this column.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.

Note: on this blog Ruggles and Smitka repeatedly examined this issue during 2008-9, arguing that, due to the interlinked nature of the supply chain, made visible in the aftershocks to the industry of the "3/11" Tohoku earthquake, the liquidation of GM would have forced suppliers and hence Toyota, Honda and the rest of manufacturing to close. Without inventory, dealers would have followed, while even repairs on existing vehicles would have become difficult because spare parts production would also have shut down. Remember, there was no private financing to handle normal Chapter 11 bankruptcy – the only alternative would have been immediate liquidation.

The Resilient U.S. Economy

If the stock market is the pulse of the American economy, the outlook might be better than expected.

In a conversation I had with noted Wall Street analyst and international trader James Vena, he asked a very interesting question: “Where was the Dow a year ago?” Answer: About 12,000. “And where is the Dow today?” About 12,000.

Vena pointed out that the economy has withstood some serious challenges this year, including:

• A debt crisis that would threaten the European economy and the Euro currency itself.
• A significant cheapening of the U. S. dollar.
• A disruption in oil supply from Libya caused by a series of uprisings in the Middle East and a corresponding spike in fuel prices.
• An earthquake and tsunami in Japan that would disrupt world trade including components for global auto production.
• Flooding in Southeast Asia that further disrupts the global supply chain.
• An attempt by a U.S. political party to hold a lifting of the country’s debt ceiling resulting in a lowering of the credit rating.
• The bankruptcy of a major legacy U.S. airline.
• Continuing U.S. housing foreclosures and a further decline in home values.

The U.S. economy is far from out of the woods. But it has withstood a serious assault in the past year and not slipped into a double-dip recession. Will the upcoming election year bring about new challenges, or will the economy get a break?

Mike Smitka as devil's advocate: but it's housing prices that are weighing down household balance sheets, not the stock market. Until you get into fairly high incomes shareholdings are primarily indirect, through retirement plans -- are Americans really going to cut back on their contributions further in order to buy a new car???? And sitting at 9%-plus unemployment for 2 years is "resilient"?

The Ford-GM Stock Equation

As with the economy, the stock market will continue to evolve. So far this year, though, auto stocks, specifically, have hit some hard times.

Surprising to many is the fact that the stock of General Motors has dropped to about $21 per share from its $35-per-share post-IPO high a year ago. Even more surprising is that Ford’s stock has dropped to about $11 per share from $18 in the same time frame. This decline, despite impressive sales gains and profits, and improved fixed costs, now that both companies' VEBAs have capped legacy costs while their UAW contracts have removed the threat of strikes and wage hikes.

Of course, in the past year there have been headwinds: high oil prices, the Japanese tsunami, and the debt crisis debacle, to name a few. Both companies have taken hits on quality, with GM experiencing bad PR due to some Chevy Volts that burst into flames during crash testing and Ford being slammed in a J.D. Power quality survey.

Despite these obstacles, the two companies have stood firm. GM announced the reopening of the old Saturn plant in Spring Hill, Tenn., to build the Chevy Equinox. Both companies continue to increase volume, marketshare, and profits. They have both been reducing incentives while maintaining sales momentum.

Once GM’s stock price gets to a certain level, expect the Treasury Department to sell quantities of the taxpayer’s GM stock. The outcome: a somewhat depressed price.

So what is your prognostication for the upcoming year? Buy? Sell? Hold?

GM recently began paying a dividend on preferred stock while Ford just announced a 5 cent per quarter dividend, its first since 2006.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs here at blogspot and writes regular columns for several publications.

From whence will they come? -- profits, that is.

In North America the pricing umbrella created by the need of the Detroit Three to fund retiree health care is unwinding, while the Europeans are fleeing the Euro to add capacity here; the Japanese began diversifying out of their yen cost base 15 years ago. In the short run, that may improve profits for the Detroit Three and the Germans at the expense of the Japanese, but will ultimatlely enhance rivalry and lower profits for the industry as a whole. Europe remains in the doldrums, and the excess capacity in China will become more apparent as sales slow to a merely torrid pace. Ditto India. Brazil? South Africa? Sure, there will be markets that grow, but will they grow faster than new capacity is added? I can't think of an exception.

That pressure is obscured by shifts among market segments, particularly in the move away from small cars in the US and China that boosted profits for some firms. It is also obscured by exit, the role of which is inadequately recognized. In Europe VW snapped up SEAT, Skoda and others while Ford and GM consolidated formerly autonomous UK and German operations. In Japan Toyota absorbed Hino, Isuzu, and Daihatsu and now has a large though not yet controlling stake in Fuji Heavy Industries, Subaru's parent. Meanwhile foreign partners have unloaded their stakes in Mazda and Mitsubishi, which face a shrinking domestic market and a yen whose value makes exports unprofitable. No one is likely to value them solely for their engineering capabilities; their demise is only a matter of time. The US looks different partly because of large capacity adjustments by the Detroit Three, but we've also seen the demise of AMC, Suzuki, Isuzu, and Mazda while Mitsubishi's plant continues to run at unsustainably low capacity. If we include the elimination of brands such as Saturn and the cessation of exports by various firms, exit is significant. Inside Korea, Hyundai gobbled up Kia while GM purchased Daewoo and Renault picked up Ssangyong. The survival of brand names makes it hard to know what operations remain. Ditto Australia, where the Ford and GM affiliates were at one time stand-alone companies.

You might say "but China." Few outsiders are aware that there were 120 firms in that market, which was dominated by a host of minuscule operations owned by the governments of provinces and large cities. They had captive markets -- the models made in Shanghai couldn't be found on the streets of Beijing, and vice-versa. Of course some of these firms and subsequent private entrants (Geely, Chery and BYD) continue in business. But the market is dominated by those Chinese firms that poured their efforts into joint ventures; they've created jobs and been able to keep a slice (as a first approximation, half) of the profits, and some of them have quietly gobbled up failing regional firms. That's important because, while the central government in Beijing has been able to eliminate the domestic trade barriers in industry after industry that impeded the creation of a national economy, the legacy of local fiefdoms remains visible in the vehicle market. VW and GM, strongest in Shanghai, have done very well. Who will "own" Sichuan Province, with a population of over 100 million? It won't be a local firm, because their exit continues.

So as I look across the world (OK, on a good day I can only see 40 miles from my mountain ridge home), well, what strikes me is the likelihood that in the aggregate profits will continue to erode. Consumer preference for choice offsets that, allowing an amazing diversity of product to survive in the marketplace. From time to time individual firms will themselves with the right vehicle in the right place, and do quite well. But that will be offset by poor profits elsewhere. In the background, there's the pressure to invest in new technologies. No one can risk not pouring resources into R&D, as regulatory pressure for safer products, lower emissions and higher fuel efficiency keeps raising the technology bar. But with expensive new and less expensive old technologies continuing side-by-side in the marketplace (and typically the dealership), it won't be possible to raise prices sufficiently to generate generate commensurate profits.

With lower industry profits, the losses for those firms that fail to hit a sweet spot will be worse. It will thus be much harder for firms that find themselves on left tail of the distribution of profits to survive. Chances are Saab won't be the last manufacturer to fold in the 21st century's second decade.

Followup: For a story focusing on this issue from that standpoint of one product, see"Toyota Threatened..." by Alan Ohnsman at Bloomberg.

Mike Smitka

Where are the French?

...they must have all the love they need at home...

Mike Smitka

First it was the Japanese. Then a couple Germans and the Koreans. Now the rest of the Germans. The Italians have one foot in the water. But except for a fleeting presence through American Motors, both with Simca as a subsidiary and later with Renault as an owner, the French -- who dominated the global industry in its formative years in the 19th century -- are nowhere to be found. Why?

Now it may be that Renault's control of Nissan represents de facto entry. Certainly purchasing is handled on a global basis, and there's cooperation in engineering. It may be that some Nissan products currently on sale in fact use a Renault platform (Perhaps one of my readers can fill in the gap.) But the absence is puzzling.

That's even more true of PSA (Peugeot-Citroen). The last time I looked (I'm probably showing my years!) they were doing well in Europe and solidly profitable. They keep up with technology, as seen in the customer base of the winners of the PACE Supplier of the Year innovation award for which I'm a judge. They're simply not here.

So what is their strategy? Do they believe that sufficient technology resides in the supplier base that they do not need sheer size to fund the R&D for tomorrow's products? Are they making enough money in small cars that they've chosen to "stick to their knitting" -- not venture into segments with which they have no experience -- and are therefore passing up the US market with its cheap gas and penchange for fuel guzzlers?

I don't know, but I've started to think about the variance in such "macro" strategy across the top vehicle assemblers. Suzuki strikes me as the closest analog, but they have a strong base in India, though it's probably no longer accurate to say that they dominate the market through their joint venture Maruti. Then there's Daihatsu, but they were gobbled up by Toyota and so, for better or for worse, are shackled to the small vehicle niche. Daihatsu long ago exited the US market; Suzuki seems likely to. So maybe PSA made a sensible strategic decision, and refused to join the herd in entering (and now exiting) the US.

My curiosity is piqued, but I have no answers.

Can an Automaker Incentive Battle Goose the Economy?

David Ruggles

As the economy wallows in the doldrums, is there any cause for optimism? The outcome of the European debt crisis is still unknown, and we know how markets despise uncertainty. There are still plenty of uncertainties associated with the so called “Arab Spring” uprisings in the Middle East, and those could be with us for a while. While fuel prices have somewhat moderated, they remain high. The country’s credit rating took an unnecessary hit, although plenty of money seems to still be seeking to buy our debt. When the Dow fell dramatically after the downgrade of our credit rating, much of the money that left equities found its way into our “downgraded” Treasury bonds. Either the European debt crisis or our government being hamstrung by ideologues has sent the Dow on a downer after the debt ceiling crisis “semi resolution.” The 12-member “Super Congress” still has an important job to do, and there is additional uncertainty attached to that, that will take weeks to resolve.

The economic recovery that seemed so promising 10 months ago has stalled. Real estate prices continue to drop in many markets with many foreclosed properties not even listed to lessen the perception of burgeoning inventories of distressed merchandise. In Las Vegas a realtor friend mentioned that 50% of her deals these days are cash, as many properties don’t qualify for a certificate of occupancy and can’t meet standards for a mortgage. Only 20% of real estate market sales are “conventional sales,” she says. To put this in perspective, previous Federal Reserve Chairman Alan Greenspan says we shouldn’t expect any kind of robust recovery until home values rise at least 10%. His comment was made in an interview before values retreated another 5%.

Unemployment has plateaued at about 9%, with under-employment and fear of unemployment stifling consumers’ will and ability to buy. The President’s new jobs plan has been met with a collective yawn by Congressional Republicans. It is yet to be determined if can even pass, let alone actually make an impact if passed. The first stimulus package of the Administration managed to stem job loss of 780,000 per month, but did not achieve its stated goal of keeping unemployment below 8%. Despite stemming the job loss, the word “failure” is bandied about in political circles. As it turns out, the initial calculations of how much stimulus might be needed were based on preliminary numbers, which showed the economy contracted 3.8% in the last quarter of 2008. Once all the numbers were in, the real numbers showed a 6.2% retraction in that quarter. It turns out that to do the job promised, Paul Krugman, Nobel Prize-winning economist and New York Times columnist was correct, the stimulus needed to have been twice as large. Regardless, we are where we are, the original stimulus has exhausted its funds, the economy is stagnant, domestic auto stocks have tanked, and recovery has been stopped in its tracks.

This economic downturn isn’t like our previous ones. This one was caused by a financial crisis, with a near-collapse of the financial system averted at the last minute by government intervention. In my own business career, I recall the auto business being a major player in dragging the country out of economic stagnation. In late 1971, Pres. Richard Nixon repealed the excise tax on automobiles, touching off a spurt of business that pulled the economy out of stagnation and carried us forward to the first 10 million unit sales year in 1973. That momentum was halted in late 1973 by the OPEC oil embargo, fuel price spikes, and the associated economic downturn. Chrysler and Joe Garagiola helped pull us out of that one in 1975 with the “Buy a Car, Get a Check” promo. We then went through the Iranian hostage crisis in 1979, another spike in fuel prices, inflation, and the recession associated with the Carter/Reagan era and the first Chrysler bailout. Chrysler’s resurgence helped lead the economy out of the depths. In the past 10 years, GM led the industry and the economy out of the doldrums caused by the Sept. 11 attack with “Keep America Rolling” and 0% interest. That was followed by the “Employee Purchase Plan.”

This time around, we experienced the recession, the near insolvency of the banking system, a real estate crisis of epic proportions, and one that stubbornly hangs on, the temporary disappearance of financing of all kinds, bankruptcies of two of the three domestic automakers, and unthinkable job loss. After the restructuring of the auto industry, and a less than perfect “Cash for Clunkers” program, and a brief period of revival, any forward momentum has stalled.

Currently, new vehicle inventories are low. This isn’t a particularly abnormal situation for this time of year, as it is typical for dealers to clear out previous year’s stock to make room for the new model year’s models. But Japanese manufacturers, in particular, have lost ground against their competition because of the supply interruption caused by the tragic Japanese earthquake and tsunami. And they want their marketshare back. According to Kelly Blue Book, Japanese brands were approaching 40% of the U.S. market. Bus since April, that share has fallen to about 30%. Most SAAR projections are running behind pace, including my own. People are talking about an incentive battle from now through the end of the year. As Japanese brands gear up, domestics are expected to respond. And the domestics now have a much lower breakeven point than before their restructuring.

Incentive wars usually drive down used-vehicle values. But we have been experiencing an acute pre-owned inventory shortage. Dealers would welcome some relief.

Rental fleet replenishment is still in long-cycle mode. Wouldn’t it be nice to rent a vehicle again with less than 25,000 miles on it, riding on smooth tires? Can a case be made for a production orgy and short cycling of rental vehicles for a period of time as we had in the 1990s? For all the negativity attached to “push-marketing,” could this be an ideal time for it? The idea of manufacturing plants running at full capacity, paying overtime and adding shifts, and the trickle down through the supplier base and the financing community sounds pretty good right now. And the market could use a supply of low mile pre-owned units. Customers of Hertz, Avis, Dollar/Thrifty, etc., would be happy. And perhaps the auto industry could help touch off recovery like it has in the past.

David Ruggles has spent his career in every phase of the retail side of the auto business, new and used, sales and management, including consulting and training in both the U.S. & Japan. Ruggles has been a dealer for Mercedes-Benz, Chrysler, Dodge, GMC, Ford, Mazda, and Subaru, and has consulted for one of the world’s largest privately owned Toyota dealer groups located in Japan. He blogs at autosandeconomics.blogspot.com and writes regular columns for several publications.

Bob Lutz - "Car Guys versus Bean Counters" Book Review

"Car Guys vs Bean Counters"
The Battle for the Soul of American Business
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