Signs Of Hope For Detroit Auto Makers

from the Economist

AMERICA’S carmakers appear to have returned from the grave. This week the three big ones—Ford, General Motors and Chrysler—all had good news to report. Ford recorded a wholly unexpected profit for the third quarter of nearly $1 billion, thanks in large part to a huge improvement in its North American operations. Sergio Marchionne, boss of Fiat and now Chrysler, laid out a detailed five-year plan for restoring the American company to health in a seven-hour presentation. Most sensationally, GM’s board, citing both the improving business environment and the firm’s own recovering financial health, reversed its decision to sell a majority stake in Opel/Vauxhall, its European subsidiary, to Magna International, an Austrian-Canadian partsmaker, and Sberbank, a Russian bank. Both GM and Ford were also able to post year-on-year increases in sales in October, of 4.7% and 3.3% respectively.

A year ago, such a turnaround seemed unimaginable. GM had declared losses of $4.2 billion in the third quarter and Ford of $2.7 billion. Both firms had burned their way through nearly $7 billion of cash each during the quarter. The smallest of the three, privately held Chrysler, did not say how much it had lost, but an educated guess was about $2 billion.

The rest is history. The government stepped in to prevent a potentially catastrophic collapse of GM and Chrysler with $62 billion of Treasury loans and then shepherded both firms through “quick-rinse” bankruptcies that shrank their debt, cut the cost of obligations to retired workers and pruned their sprawling dealer networks. Italy’s Fiat was recruited to take over the management of Chrysler and share its advanced technology for small cars in exchange for a 20% stake. Ford struggled on, completing its restructuring without help either from the taxpayer or bankruptcy, thanks to the $23.6 billion it had raised in 2006, before the credit markets froze, by pledging all its North American assets as collateral.

All three firms will now be helped by what may be a quicker and stronger recovery in car sales, particularly in America, than most people are expecting. It will be a long time before sales return to 17m a year, the level until recently regarded as “normal” by an industry accustomed to pumping up demand with cheap credit and suicidal pricing. But Adam Jonas, an analyst with Morgan Stanley, points out that previous recoveries in car sales have been “V-shaped” (see chart), and that this one is likely to be too.

After sales hit a low this year of only 10.5m, Mr Jonas is forecasting sales of 12.8m next year and 14.5m in 2011. He is relying on the combined effects of broadly based economic recovery, especially in the housing market, and the unprecedented age of the car fleet, which has typically peaked after seven years of consecutive increases in cycles going back to 1970 (the last inflection point was in 2001).

Since emerging from bankruptcy GM and Chrysler have reduced the level of annual sales at which they can break even from more than 16m to 10m. Assuming that neither loses much more market share, both should start making an operating profit next year. Meanwhile Ford’s chief executive, Alan Mulally, said this week that he was changing his guidance for 2011 from break-even to “solidly profitable”.

There the similarities end. Of the three, unquestionably the best performer has been Ford. In America its market share has leapt by 2.2 percentage points over the past year to 14.6%, helped by the acclaim it has earned by avoiding bail-out and bankruptcy and by the good reception given to new models such as the F-150 pickup, the Taurus and the Fusion Hybrid.

However, the decision to forgo the fresh start of bankruptcy means that Ford’s debt will rise to around $35 billion after payments are made to a retired workers’ health-care fund. Ford is also paying a price for its independence in another way. Under the terms of the overhaul of GM and Chrysler in bankruptcy, the autoworkers’ union made substantial cost-cutting concessions in return for a big share of the equity in both companies—concessions that the union this week voted heavily against extending to Ford.

As for GM, fears that bankruptcy might terminally undermine customer loyalty appear to have been overdone. GM’s product portfolio, although some two years behind Ford’s in competitiveness according to Mr Jonas, is steadily improving and has the potential to make a similar turnaround. Better quality, advertising targeted on only four brands and the improvement in used-vehicle values that is coming from no longer chasing volume at all costs should all speed GM’s revival.

The decision not to part with Opel/Vauxhall, although infuriating to the German government and the unions, is a sign of GM’s growing confidence. It had never wanted to sell Opel, which despite being lossmaking is GM’s main repository of expertise in technologies for smaller cars. But it felt it had no option until the European Commission forced the German government to promise that a proposed €4.5 billion ($6.7 billion) loan would be available to any investor, and not just Magna. Keeping Opel will allow GM to mimic Ford, which plans to meet growing demand for small and medium-sized cars by manufacturing in America products first developed in Europe, such as the new Fiesta.

Despite a typically bullish performance by Mr Marchionne on November 4th, doubts about the future of Chrysler will be harder to dispel. In contrast to Ford and GM, Chrysler’s sales last month were 30% down on a year ago. It is hamstrung by an absence of new models and negative reports on the quality of its vehicles.

Perhaps the best news that Mr Marchionne delivered was that Chrysler had $5.7 billion of cash at the end of September, compared with $4 billion when Fiat took over in June, and that it should make a small operating profit next year—testimony to phenomenal cost-cutting in bankruptcy. The relentlessly upbeat presentations by a succession of Chrysler executives (nearly all them new to their posts) provided a road-map of how the partnership with Fiat will transform the company and its ability to develop at speed cars that customers will want to buy.

Together they made Mr Marchionne’s target of doubling worldwide sales to 2.8m by 2014 sound almost achievable. The worry is that there is no quick fix for the lack of new products. For the next couple of years Chrysler will have to rely mainly on facelifts of existing models and urgently-needed improvements in quality. The biggest question is whether that will be enough to lift Chrysler’s market share well above its current 6% before a range of new products based on Fiat’s platforms and powertrains starts to appear in 2012. If Ford and GM are in the recovery ward, Chrysler remains on the critical list, for now at least.