Europe's Troubles: BMW postscript

...my quick analysis suggests no European OEM will weather the coming storm without taking on a fearful amount of water...

According to an August 16^th Bloomberg post on BMW, discounting is rampant in the German market, while sales are not responding. (According to a friend who has worked in Europe, this phenomenon of phantom sales goes back decades, rediscovered in each recession given that the careers of analysts and reporters of the industry seldom span multiple downturns.) Now I visited BMW's plant in Spartanburg, South Carolina in January 2012; it was running flat out and adding capacity, because the models produced there are global hits, with the majority of output exported. My back-of-the-envelope calculations suggest that plant is about 1/5^th of BMW's global output, given capacity additions in China.

Of course a big slice of those exports go to Europe, which is in recession; overall the region accounts for 30% of BMW's sales. The elimination of the "block exemption" in late 2003 removed restrictions that limited the ability of dealerships to sell cross-border; German stores now compete with those in Italy. As long as the euro lasts, troubles in one large market now spill over to the rest of Europe. [And if the euro doesn't last ... but that's my premise.] Meanwhile growth has slowed in the BRICs, which account for 25% of sales.

So while the European near-luxury makers are more diversified than Peugeot, Renault or Fiat, they too remain vulnerable.

And then there's the massive VW empire, 10 brands including a full range of trucks, and a solid sales base in most markets except the US and Japan -- and it is now targeting the US aggressively. However, with a market share of just over 4%, its footprint simply isn't large enough to generate sufficient profits to offset weaknesses elsewhere (and with a new plant, depreciation looms large, good for cashflow but not the bottom line). To analyze how the firm will weather the looming European meltdown would require piecing together these operations. Analysis is further hampered by the lack of geographic data in the stock analyst reports I've scanned. They may be the best immunized -- but I can't make a case one way or the other.

...Mike Smitka...

Addendum: Pending blog post I spent over an hour discussing the European industry with a retired senior Detroit 3 executive whose career included multiple postings to Europe. He helped point out variations across firms and markets, a level of detail beyond my experience or ability to quickly [this is a blog!] research. More once I hit a comfortable rhythm with my teaching overload this fall, and add nuance to my analysis of Europe.

GM and the Upcoming Presidential Election

Ruggles – September 2012

Amid the political turmoil of election season the rescue of the domestic auto industry by the George W. Bush administration and the Obama Administration is certainly a political football. The President and the Democrats have to defend the fact that the “rescue” wasn’t done perfectly, although a debate rages over exactly what those imperfections might be and who is responsible for them. Many Republicans are sticking to their position that the domestic auto industry should have been allowed to liquidate and eventually reform, although that logic doesn’t play well in the key “swing states” Ohio and Michigan. Governor Romney was adamantly against the “bailout” saying “Let Detroit go Bankrupt” and declaring that “a bail out would insure their failure.” Of course, this is all confused by Romney’s attempt in the Republican debates to actually take credit for the rescue saying, “They took my advice.” (His campaign has repeatedly declined comment when asked to clarify their candidate’s position on the issue.)

It also seems to ignore the fact that in the case of liquidation, there would have obviously been a huge cost dropped on the various states for unemployment compensation, a ripple impact through the banking system, chaos in the supplier base, and a disruption of military procurement. The ultimate result could have been a true Depression. Most pragmatic politicians wouldn’t have taken the risk, despite rhetoric to the contrary.

Some of the criticism leveled at supporters of the auto manufacturer rescue is based on the fact that if GM stock were liquidated today, based on its current value which is down a third since its’ IPO date, the taxpayers would sustain a loss in the tens of billions of dollars, which is entirely true. Of course, no one has calculated the cost of NOT doing the rescue, a calculation which would have to be based on speculation and would be subject to considerable argument.

Another issue rarely heard has to do with the billions of dollars of pension liabilities that would have been dropped on the Pension Benefit Guarantee Corporation. While a close estimate of that financial burden is not available, a comparison is. When United Airlines dropped their pension liabilities on the PBGC about 8 years ago as a part of their Chapter 11 bankruptcy, the amount was $6.6 billion. While this is technically an insurance fund, the obligation for pension obligations abrogated by liquidating OEMs and suppliers in the case of an auto industry liquidation would have easily run into the tens of billions of dollars, rendering the fund insolvent. This would have either landed on the back of taxpayers or pension checks would have ceased for many retired Americans. The impact on the psyche of the country and on consumption in the economy can only be imagined.

In the meantime, President Obama and Governor Romney and their political parties have both been banned from GM properties until after the election. There will be no political grandstanding on bailed out automaker facilities! Imagine banning the person who represents one of your largest stockholders, without whom you would not exist.

The two automakers have also refused to furnish vehicles for the national political conventions. It’s a smart move for GM and Chrysler to stay away from politics when possible. After all, they want to sell vehicles to both Republicans and Democrats.

While things are somewhat different for Chrysler now that FIAT has bought out the Federal Government’s stake, are GM executives hedging their bets in case President Obama loses in November? While it hasn’t been talked about a lot, it has occurred to more than a few GM stockholders (myself included) what would happen if Romney is elected and immediately dumps all of the government’s stock in General Motors. This would certainly be devastating for the stock price, but what does Romney have to lose? He could claim to have relieved of GM of its Government Motors moniker, while hurting millions of private stockholders. He could blame the losses on the previous administration, and move on. If reelected, it is a given that President Obama would hold on to the GM stock, selling small amounts at a time to maintain the stock price, while hoping the improving economy would further bolster the value of the taxpayer’s stock.

It is also a given that President Obama’s role in the restructuring in the domestic auto industry gives him a serious advantage in the November election. It is hard to imagine Ohio and Michigan going Republican. And without those two states, the road to the White House becomes a near impossible journey. And if GM shareholders across the country get wind of Romney’s intent to dump the taxpayer’s GM stock at once, it could impact the way people vote in other closely contested states.

The Industry in the face of the Euro's (partial) demise

...Eurxit and beyond...

The Euro as currently configured is not sustainable, from both an economic and from a political perspective. Spain cannot possibly deflate its way back to balance, and 20% overall unemployment and 50% youth unemployment is not politically tolerable. The only way out – forcing German banks to write off their Spanish debt now, matched by stimulus sufficient to turn Germany into a net importer – is not on the policy horizon, though in due course German banks will in fact have to write down debt.

If Spain falls, so will other parts of the Euro zone. Greece of course, and Portugal, and Ireland but not Italy? – I'm not euro-centric and don't know enough to create my own list. I assume France, Spain, Benelux, Austria and Finland will remain. To highlight issues, however, it is sufficient to focus on Spain.

The Euro exit process – I've seen the term "Grexit" used for the likely initial case – is not clear-cut. I would hope that central bankers and pan-European financial institutions are (quietly) working on possible scenarios. If so, in our leak-prone world, they really have been quiet. At the moment, a sensible assumption might be a three years of chaos in those exiting, since there seems to be no planning to support a quick and clean break (cf. the 1997 Asian Financial Crisis). In the interim, those remaining on the Euro would face a corresponding period of deep recession. Then would come two years of recovery that would leave economies below peak, followed by an era of more gradual reconstruction. The total: five lean years, less than what drove Israel to Egypt, but potentially just as devastating to the European heartland.

Not all auto firms are equal. For several – Fiat, Peugeot and Renault – Europe dominates their operations. So far VW appears exceptional, because its German sales base has escaped the current crisis and it is larger outside Europe. Then there are BMW and Mercedes, in the upper segment of the market, about which I know little, and so will hazard no guesses.

Other firms have a footprint in Europe, but are not dominated by what happens there: Fordwerke and Opel are but one part of the global operations of Ford and GM. Europe is peripheral for Toyota, Nissan, Honda and Hyundai. Their parent companies may or may not decide to tough things out – GM will have the hardest time –but unlike Euro-centric firms they have the option of exiting. That would matter if both Ford and Opel/GM leave the market, but otherwise would not remove enough capacity to change the equation.

Then there are automotive suppliers, the larger of which have substantial bases in the Americas and Asia, but still have their core in the Euro zone. My sense from visiting suppliers on a regular basis is that they've done a good job of geographic rebalance, to the benefit of firms headquartered in Europe and the detriment of those headquartered in the US. Asian suppliers are on average relatively weaker in Europe, and so will be less affected. Catastrophic failure of any of the large European suppliers would be catastrophic to the industry, the equivalent of Lehman Brothers in the financial world. Renault would (quietly) cheer the failure of PSA or Opel. All would lose in a meltdown of the supplier base.

Shifting gears from firms to geography, Eurxit (pardon the neologism) would bring a large devaluation to Spain. That is most obvious relative to the Euro; imports from Germany and France [Grance? Framany? – the new Europe will need new jargon] would be much more expensive. However, I would also expect the (new) peso to depreciate relative to currencies in peripheral Europe, since Hungary, the UK, Russia and Turkey already reflect a more sustainable level relative to the Euro.

If it could avoid collapse during the transition, Seat as a local firm (albeit also a VW subsidiary) would benefit from a large shift in relative prices that would improve its strategic position. It could become a true value brand in Europe, with increased exports and (due to the higher cost of imports) would have a near-unassailable position in its home market. Seat might still be Skoda's poorer brother, but its place in the VW family would be more secure. Now the labor cost component of local [Spanish] assembly is modest, and many parts and components are imported, muting the initial benefit. Over the space of a few years, however, local content would rise and with it the peso component of the cost base.

In contrast, firms remaining in the Euro cost base would see their export markets shrink, and the burden of the zone's excess capacity is already heavy. Who has deep pockets? VW, yes, but (potentially) Ford, Opel, Toyota, Nissan, Honda and Hyundai. Chrysler isn't big enough to fully balance Fiat, nor Nissan to balance Renault. Absent government intervention, it is hard to imagine all of these small firms surviving five lean years. In addition, GM's pockets aren't deep; Ford is still rebuilding its balance sheet. Eurxit won't help the US economy and it won't help China, so won't help either firm. So it is conceivable that one of them would exit. It is almost inevitable that the European market would witness multiple bailouts, given a greater political sensitivity to unemployment than in the US. This would be to the detriment of VW, and to any of the branch operations of US and Asian-based firms that remain.

This is my first pass at the implications of Eurxit. Additional differentiation would come from breaking down market shares of individual firms between Eurxit and Euro countries; who is strong in the Mediterranean periphery, and hence more vulnerable? Who has the weakest balance sheet among OEMs and among suppliers? On which side of the divide will Italy lie? Who has a stronger base in the non-euro periphery (Turkey, Hungary, Poland, Russia) and so may be better positioned to pick up pieces of the market via exports?

We can always hope for a miracle European unity, that France and Germany can act as one. So far the fear factor is failing to force fraternity. The initial Eurxit – Grexit? – may change that, but my hunch is that by the time it will be too late.

Finally, this places a fundamental strategic choice in front of firms not irrevocably committed to Europe: do you marshal resources for a long and expensive slog there, or do you prepare to retreat and instead concentrate on the Western Hemisphere and Asia? Even with a reconfigured "euro" divide Europe will remain on average prosperous, and with a population larger than the US will remain potentially profitable. But is every current participant willing to wait until 2018 to realize that potential?

...Mike Smitka...

The REAL Reason Recovery is Slow

...from Auto Finance News...

2012 June 2012 was a huge news month. The 2012 Presidential campaign is always good for news, the Miami Heat won the NBA Championship, we had fires and storms, and the Supreme Court issued to important rulings on the Arizona illegal immigration legislation and the Federal health care reform bill commonly known as ObamaCare. Lost in all of this was a report released by the Federal Reserve Bank which dealt with the issue I believe is the real reason for the slow recovery. It’s not taxes. It’s not regulation.

The Federal Reserve report that shows a decline of almost 40% in household net worth from 2007 to 2010. In that time span American’s household wealth dropped to a level not seen since 1992, mostly driven by the precipitous drop in home values due to the bursting of the housing bubble. Eighteen years of gains were wiped out.

The new data comes from the Fed’s Survey of Consumer Finances, a report issued every three years that is one of the broadest and deepest sources of information about the financial health of American families. Families with incomes in the middle 60 percent of the population lost a larger share of their wealth over the three-year period than the wealthiest and poorest families. This is typically the group that drives consumption in our economy. Given the scale of this loss of household net worth and in the face of other headwinds like the European debt crisis, it is a wonder we have had the recovery we have had.

Unless one belongs to what some call the “Field of Dreams School of Economics”, (If you build it they will come), one probably believes that the country’s recovery is stymied by weak demand. This Federal Reserve report quantifies the reason for that weak demand.

In the midst of the current Presidential election we haven’t heard much from either candidate on the subject. Mitt Romney seems to want to hasten the foreclosures and subsequent sales to get deficiencies established so the “bottom” can be reached. I’m not sure that carries favorable political resonance but he said as much during a recent interview. Romney regularly states he thinks that it is taxes, threat of taxes, and regulation holding the economy back, not the evaporation of household wealth. But he can gravitate from being a “supply sider” to a “demand sider” in the blink of an eye.

President Obama has offered up some measures to help keep people in their homes, like the Home Affordable Refinancing Plan (HARP). While HARP and other programs carry positive humanitarian considerations, they might be helping to extend the problem. Unfortunately, it won’t be good for the country if we use the high point of the bubble, 2004 – 2007 as our economic benchmark. The consumption of that era was based on many Americans using their home equity as an ATM machine. A return to those days would mean we would be on the edge of another disaster.

Until consumers feel confident and “wealthy” enough to begin robust consumption, recovery will continue to inch along despite immense pent up demand. Real recovery depends on home values.

The complete report can be found at the link: http://www.federalreserve.gov/releases/z1/current/z1r-5.pdf

PS: For more on the impact of this sort of decline in wealth, readers might look at the following post on a survey of "balance sheet recessions." As far as I know -- I happened to be at an early presentation of his in Tokyo in 1992 -- the term was coined by Richard Koo. The blog entry which provides a non-technical overview of this survey is HERE.

Mike Smitka

...see the companion blog usandeconomics.blogspot.com on RomneyCare...

Bad News for Toyota? – the Detroit 3 are Back

...the Detroit 3 are returning to the midsized-car segment...

I'm tossing out back issues of Automotive News to try to fit into a corner office with more windows but less shelf space. I know, crocodile tears for this academic with his shelf-filling collection of books and journals. Anway, one headline caught my eye: "What can save the Detroit 3? Cars!" [a John K. Teahen, Jr. editorial from Sept 18, 2006, p 16].

The context was the near-exit of GM, Ford and Chrysler from the car market, which decreased monotonically from 89% of their sales in 1965 to 35% in 2005, while (correspondingly) trucks went from 11% to 65%. Now admittedly trucks were incredibly profitable on a unit basis, while small cars were a necessary evil, intrinsically unprofitable but needed for CAFE (the Corporate Average Fuel Economy mandate). But the decline at the Detroit 3 was disproportionate to the shift towards light trucks in the over US market.

One point is that ambitious designers, engineers, and senior managers all want to be associated with halo the ka-chenk of good bottom-line vehicles. Teahen argued that the Chevy Impala remained a potential money-earner, with hoped-for sales a bit above the 296,000 of 2006. In fact, on a platform basis, output was higher – 500K – reflecting the multiplication of nameplates that were in fact the same basic car, but the implication of the editorial was that it wasn't making much money. And even with the shift of the overall vehicle market towards light trucks, such sales pale besides the 1-plus-million mark hit of 1965. GM wasn't putting its heavy hitters on car projects.

I've argued before on this blog that Toyota lavishes undue attention on the Prius and on the Lexus marque, again reflecting the status of these projects within the company as a whole. Reputedly Toyota's working to correct that bias, devoting more effort to the 2012 version launched in December 2011. Time will tell if it is better executed and better selling.

Today, however, the Detroit 3 are a factor. They have very different cost structures, with the removal of the millstone of legacy costs from around their neck, a function of the aging of workers "retired" under pre-2007 restructurings, the impact of the VEBA and (for GM and Chrysler) additional costs shed under bankruptcy. Labor is no longer a fixed cost. They thus no longer need to maximize revenue [which for you economics junkies is also implied by the low marginal price of labor]. Instead they can aim to make money from cars. We see that in reduced incentives, reduced fleet sales -- that is, higher prices -- and a normalization of residuals. (I can't speak of leases -- I lack knowledge and suspect that option continues to suffer from the aftershocks of the financial upheaval of 2008-9.)

What does that imply for those who remain focused on cars, particularly Toyota, Honda, and Nissan? On the one hand, they ought to benefit from less discounting. On the other hand, they are hurt by reinvigorated Detroit 3 products. The latter, I believe, dominates: from Toyota's perspective, they have two new, heavy-weight competitors in GM and Ford (and in some product categories, a 3rd in Chrysler), and while Hyundai has been around for a while, sales of the Sonata are only now such as to represent a major slice of the mid-size segment of the Camry and the Accord. If you've become a bit sloppy dare I say arrogant? the sudden appearance of new competitors can be very painful.

My prediction thus is that Toyota (and Honda) will resort to greater discounts and higher fleet sales. That should be good news for new car buyers. (Car renters will have greater choice, but price may not budge much, better residuals will work against higher initial acquisition costs for Enterprise and their rivals.) But since Toyota relies on exports from high-yen Japan for Lexus and (to a lesser extent) the Prius, they've taken a major hit to profits on that front. I'll leave it to financial analysts to pour over segment results of the major players, particularly Toyota, to see if the new competition means their US profits take a hit as well.

Mike Smitka

comments welcome, here or via email!

Reverse Import Deja Vu?

...a strong yen should boost exports to Japan...

In 1992 I wrote a paper about Japanese car imports, later picked up by the Economist, in Japanese by Toyo Keizai (東洋経済) and by the MIT International Motor Vehicle Program about the growth of Japanese car imports. Ah, but what news was in that? Well, I was writing about "reverse" imports by Japanese of their cars from the US to Japan, alongside the sales of German firms, the only foreign companies to set up proper dealership networks and import processing infrastructure. The recent strength of the yen against the US dollar and particularly against the Euro, made me wonder if we will see a return to that era.

A headline in the May 24th Sankei Shinbun web site thus caught my eye: Mercedes-Benz will sell the "Smart for Two" for ¥1.59 million (US$19,992; €15,950), about a 14% reduction in price. Other forthcoming models of M-B and BMW will likewise carry lower sticker prices or add a lot of options without raising the price. Now the article doesn't make it clear whether the base is appropriate -- it uses year-on-year comparisons, and in general spring 2011 was not a normal time. Still, it cites rises of 37% for M-B and 27% for BMW.

I've only glanced quickly through recent data: given the volatility of the global economy in general, and the post-3/11 economy of Japan in particular, I was expecting to find the data too noisy to interpret. That's not the case.

First, overall imports are at the highest level in the years for which I have (FY1999 to present), even though at 4.0 million cars FY2011 sales are 10% below their mid-2000s level (and 20% below the 5.1 million unit sales peak at the top of Japan's bubble in 1990).

Second, while the German firms are doing OK, both BMW and Mercedes are down from 2007 and the onset of the global recession; only VW and Audi show signs of a sustained increase. What really is driving the increase is Nissan, which now accounts for about 17% of imports or 50,000 units. This is surely consequent to their moving the production of certain vehicles (such as the March) entirely out of Japan.

Still, total imports of 295,000 units remain rather short of the 393,000 level of 1996. While the Japanese media may be full of hand-wringing about the impact of the yen, the evidence so far is modest, when looked at through the lens of vehicle imports. Realistically, it's probably too soon to tell; vehicle sales strategies are penciled in a couple years in advance. We aren't seeing "reverse imports" of Japanese-brand cars from the US -- yet. So from that perspective we're also not back in 1996, when 85,000 Toyotas and Hondas went westward across the Pacific. But it is worth watching.

Source: 「１５９万円のベンツ 円高追い風、価格抑え輸入車加速」 which freely translated says "Fanned on by the strong yen, a Benz at ¥1.59 million will accelerate imports." From sankei.jp.msn.com of 25 May 2012.

...Mike Smitka...

Who Would BUY a Chevy Volt?

Who In Their Right Mind Would BUY a Chevy VOLT?

After all, it’s $40K – think about what else one can buy for $40K! There are very nice Lexus, Benz, Infiniti, BMW, and Cadillac models in that price range. AND even with a government subsidy it doesn't stand on its own at $40K. Even if gas hits $5, it doesn't work. Plus who knows what it will be worth in 39 months, or 36 or 48 for that matter. If new technology trumps it, it could be next to worthless. Why take the risk just to be known as an "early adopter?" That's why Bob Lutz, the Father of the VOLT, told us at a fleet conference a while back, "It won't SELL. That's why we're leasing them for $350/month for 39 months."

Lutz says, "We gotta start somewhere if we EVER plan on achieving economies of scale." In true Lutz fashion he compared the VOLT to hunting ducks. "If you shoot at the duck, you will miss it every time. One has to "lead" the duck to hit it. We need to lead the market to have a chance to hit it. If we wait too long, the train has left the station and we are standing on the platform saying, "What happened?"

"Lead, follow, or get out of the way, said Lee Iaccoca. Lutz concurs.

Toyota lost money on every PRIUS beginning in 1996, and did for quite a while. That vehicle is thought to be profitable these days, although they are typically "tight lipped "on such matters. Toyota is now bringing a plug in hybrid to market. (The VOLT was the world’s first plug in hybrid.) Toyota has lots of experience and satisfied hybrid customers now, along with economies of scale.

In the meantime, the VOLT has attracted detractors. The Right Wing in the person of Rush Limbaugh has embraced the VOLT as a car they can hang around the President's neck, despite the fact it had been in development long before he was elected. Actually, Lutz IS the actual "Father of the VOLT." For Lutz to get after the Right Wing takes some doing -- see his Forbe article.

The barrage of untruths continue. A friend from told me that it would take 3 weeks to drive across the country in a VOLT with all the stops to recharge. He said heard it on Right Wing talk radio. In fact, the electric range on VOLT is about 45 miles before the internal combustion engine takes over to propel one across the country as with a normal car. It IS true that the internal combustion engine recharges the batteries which drives the electric motors rather than being actually connected to the drive train in a conventional manner. But to the driver, the difference is not noticeable except the engine doesn’t change RPM based on throttle position.

Others claim they catch fire in a collision. The VOLTs that caught fire had been crash tested and stored improperly for weeks before they caught fire. A vehicle with a regular lead acid battery stands the same risk if stored improperly. As with normal vehicles, the battery should have been removed.

A driver with a less than 30 minute commute to work, and a place to plug in while there, could drive all month without the internal combustion engine using any fuel at all. Figuring 50 miles per day plus other driving, one saves two tanks of fuel per month or about $120. Subtract that from the $350 lease payment and the VOLT can be easily justified. BUT GM has NOT made that case. Worse yet, sales people in Chevy dealerships haven't either. And coupled with the Right Wing misinformation blitz, GM has shut down production for 5 weeks to balance inventories. In my mind, the story has been that GM has not done the math for consumers in their marketing efforts. The marketing story is "$350 minus $120 equals $230./month. That WORKS!!!!!

[Smitka: But obviously consumers don't do the math -- ditto with the Prius, as there's no strong case for buying it on the basis of fuel savings, which is why no other hybrid, including those made by Toyota, sell well. In other words, people buy a Prius to make a statement – hence you don't find "base" models on the lot, the main reason Toyota may make money on the vehicle, despite the cost of installing two powertrains plus a battery pack. GM needs to borrow a bit of that marketing. At the moment, of course, so does Toyota....]

David Ruggles, April 17, 2012