Editor's note: This story is the first of a three-part look at the deepening crisis at Ford and GM. This article originally appeared on RealMoney on Aug. 22.
Over the last 12 months, the brutal sales slump in Detroit has dominated the headlines. Even as the automakers show few signs of slipping out of their funk, the balance sheets are likely to become
top story out of Motor City for the next 12 months.
are burning cash at an alarming rate. And while both are moving aggressively to shrink their cost base, Ford's balance sheet is far more likely to emerge intact, while GM's entire capital structure looks to be an Achilles' heel.
Although I will be assessing the one- to three-year outlook for each firm in subsequent pieces, it's important to first look at the major trends that are impacting all of the automakers.
Two Tons of Steel, Collecting Dust
As has been widely noted, the automakers are taking a one-two punch with the sudden plunge in truck sales. Not only did those vehicles constitute a big chunk of sales, but they also accounted for an outsized proportion of profits.
These days, pickups and SUVs are piling up on dealer's lots, which is proving to be especially problematic for GM and Chrysler, a division of privately held Cerberus. As the accompanying table shows, dealer lots are bulging with these vehicles, and the unsold pile is expected to rise higher when third-quarter figures are released.
Chrysler was sitting on 108 days' worth of unsold vehicles at the end of July, compared to 83-84 days for Ford and GM. Auto inventories typically decline in July to below 60 days, as plants are shut for model-year changeovers.
As is the case with any industry, rising inventories lead to profit-sapping price wars. Automakers had vowed to throttle back on incentives, but are clearly desperate to move the metal.
GM and Chrysler get much of the blame, as they have maintained relatively high production rates, even as the sales slump deepened. In contrast, Ford moved quickly to furlough plants and is transferring several factories from truck production to car production.
Incentives are typically $2,000 to $3,000 on cars, and in excess of $5,000 for Ford and GM trucks. Chrysler's trucks carry an eye-popping $9,800 in incentives, according to Credit Suisse. (Among European brands, Saab takes the cake, with roughly $6,800 in incentives per vehicle).
Eerie Similarities to the Housing Crisis
Besides the negative impact of rising energy prices, the auto industry's woes are rooted in the same factors that hit housing. Throughout much of the last 10 years, vehicles were selling at an unsustainably high pace, thanks in part to aggressive financing.
By 2006, many consumers were living in new subdivisions with new vehicles parked in their driveways. Two years later, many of those consumers are feeling financially strapped and are selling their vehicles -- especially trucks -- to raise cash. So that glut of unsold new vehicles is being exacerbated by a rising tide of used vehicles on the market.
When the automakers offered low-interest leases and loans, they assumed unrealistically high resale values. Now that prices of those used vehicles are tumbling, their finance divisions are sitting on a rising tide of bad loans, just like the mortgage originators.
(Adding another dose of pain, GM's exposure to the mortgage business has brought another set of liabilities to tackle, as I discuss further in Part II of this series.)
On a company-specific basis, sales at Ford are off 21.5% from a year ago, while sales at GM and Chrysler have fallen 32.4%, and 34.2%, respectively. While the sales weakness at GM and Ford has been especially notable in light trucks, Chrysler is seeing lousy demand for both cars and trucks.
Chrysler on the Ropes
Realizing that it was "losing money on every sale," Chrysler recently decided to stop offering leases. Simply put, the company is burning cash so quickly that it likely lacks the funds to back up its financing arm. Analysts speculate that GM might have to go the same route, which could turn out to be a real boon for Ford and the foreign manufacturers, as many consumers that lack the cash for an outright purchase take their business across the street.
Since Cerberus is privately held, investors cannot get a sense of the depth of Chrysler's problems. But the sales drop-off at Chrysler has been the most dramatic in the industry. The company's current product line is completely uninspiring, and Cerberus is ill-equipped to provide funds to invest in the research necessary to keep up with the latest advances in engine technology.
Consumers are already wise to the weak line of cars offered by Chrysler. The company sold 9% of all passenger cars in January of this year. By July, that figure had dropped to just 4%. And Chrysler's historical 19%-20% market share of truck sales has fallen down to 14%. That's a smaller slice of a far smaller pie.
Chrysler was "too big to fail" 25 years ago. This time around, many foreign brands have built a robust domestic manufacturing base, and the question of whether Chrysler is an icon worth saving is quickly becoming moot.
If Cerberus doesn't put the vaunted Jeep brand on the block soon, then Chrysler could end up defaulting on its bonds. If that happens, the whole house crumbles as vendors impose increasingly onerous COD terms.
More Pain ... and Then a Rebound
While many analysts had assumed that total industry unit sales would drop roughly 2.2 million to 14 million units this year, some now wonder if a tepid second half might lead to just 12.5million to 13 million units. That would be the lowest level in 16 years.
Over much of this decade, annual sales were in the 17 million range, though the industry would be thrilled to sell just 15 million units in 2009. At that level, Ford would likely operate near or above break-even, while GM would burn far less cash than is currently forecast. Most analysts think both carmakers will move back into profitability by 2010.
To be sure, there is no reason to expect sales to turn up sharply later this year, even though gasoline prices have begun to moderate. And weak sales will surely lead to continued massive losses for Ford and GM in the third and fourth quarters.
But as will be reviewed in the subsequent columns, Ford has enough cash to withstand five or six more quarters of pain, while GM's well might run dry far sooner.
The five- to six-quarter time period is crucial. In that time, sales are likely to start to rebound, if only because the fleet of light trucks is aging at a steady clip. Moreover, in Ford's case, a range of new engines are expected to offer vastly better fuel mileage, which will blunt the pain of the cost of a new vehicle, even if the consumer remains under duress.
In sum, this bleak period for Detroit looks set to get even bleaker. But a closer look at the financial strength of each of the players implies vastly differing outcomes for shareholders.
David Sterman has been an equity analyst and financial journalist for 15 years, most recently serving as Director of Research at Jesup & Lamont Securities.