Saturday, 7 May 2011

Micro Level Trends - US Autos - The Need to Generate Profitability from the New Social Glee

The US surgical assault in Pakistan to annul Osama bin Laden could not have been better timed for the US economy. Acting as it does as uplift for the social psyche.

It obviously also a boost to President Obama's previously flagging popularity, almost as if it were timed to reflect his words pertaining to the importance of the national agenda versus the far right's intentions for rumour-mongering.

It also coincides with the posting of Q1 2011 corporate financial results, in which old fashioned heavy industry has demonstrated itself as fundamental to America's renewel prospects. The likes of Caterpillar and Cummins Diesel (as highlighted by the FT's Tony Jackson) demonstrating the intrinsic worth of 'smokestack' industry both as an export earner and as homeland economic pillar. The momentum seen thus far has been impressive - as Jackson points out seen in valuation multiples - yet maintaining earnings and growth traction is of course vital if the re-balance of the economy from Wall St to Main St is to progress.

So whilst much noise about the killing of America's '#1 Most Wanted' fills the popular media and blogsphere, ranging from conspiracy theory to citations of disrepectful burial methods, the real focus is still on the US economy, and the question of “what next?”

History demonstrates the link between US national security (ie threats v confidence) and national output. Washington Administrations over the decades seeking to re-balance the economy when it sees capital markets contract in reaction to a threat. Done so by raising foreign & domestic
defence spending and expenditure on public goods & services. Latterly as the upturn begins then once again re-balancing with state-level spending reductions. This part and parcel of policy-making for all notionally free-market and mixed-market nations.

However, the unprecedented US (and global) concern today is regard the level of US indebtedness, critically the capital market's sensitivity to perceived ability/inability to re-pay that debt. Whilst some see America as still unrivalled as the super-power, others see its national balance sheet and basic accounting as akin to that of Greece, Ireland or Portugal; simply on a far greater scale. The main difference however relates to military might on the global stage, something the European fringe nations do not have. It has been its 'hard' and 'soft' power that has sustained the US to date throughout economic downturns.

This clearly demonstrated by the bin Laden attack. However, the presumption is that whilst the head of the snake has been removed, a general threat still exists, yet perhaps more opaque without the same organisational framework, thus presumably making terrorism intelligence gathering harder.

Nonetheless, in the President's own back-yard the bin Laden's apparent demise is a welcome milestone as a 'psychological closure' for the US. It gives reason for national celebration aswell as rememberance. The effect on the capital markets have been largely negligable, more of a Main St event than a Wall St one. Thus even if though there are many questions surrounding the validity of the event, the long-awaited vanquish for 9/11 has come, for Americans it heralds that "we got him!".

The desired effect is that the 'victory' becomes the conversation piece in offices, factories, bars and dining tables across the land, and that it builds innate patriotic confidence. A much needed confidence whilst in the present drudge and malais of high unemployment, inflationary input costs to industry and food & energy. A confidence set to boost the country's mood and in tandem, ideally, its consumptive attitude.

The good news story will have seen celebratory consumption boosted across food, alcohol and no doubt a raft of tacky bin Laden-directed merchandise. Yet the real hope is that translates into bigger ticket spending, none more so than Autos as a form of personal reward and view of a brighter future.

For Washington, growing domestic consumption levels at this critical point in time is vital, and the Obama Administration knows it only too well. The government-driven revival, whilst effective in the short & mid-term, must be superceded by real wealth generation created by industry and the public at large.

Thus far, even whilst still in an economic 'low-gear', the uptake in US Auto sales from commercial and private purchases has been has been keen, seeing vehicle market TIVs climb from the low of 9.5m in 2007 to an expected 12.5m in 2011.

Of course, this was largely due to the availability of Treasury supplied, and latterly Wall St injected, liquidity pumped directly and indirectly into car-makers via part-nationalisation, cash-for-clunker schemes (which at one high-point in early 2009 boosted cars sales alone exc trucks to an ASA rate of 8m) and consumer-credit pumping in support of GM & Chrysler after respective re-structuring. Indeed, GM's IPO perhaps more about generating economic confidence than the (seemingly so far lost) effort to recoup the Federal prop-up costs.

Thus, on paper, given the level of assistance provided by Washington, the new incarnations of GM & Chrylser have made progress

From this perspective, the Q1 financial results of Detroit's Big 3 automakers give cause for general satisfaction within Washington. On Wall St though the sell-side and buy-side analysts believe that a greater portion of the profitability the 'middle-line' reporting shows should have been paid to institutional and retail investors. This done to retain faith in Detroit's Big 3', and done to reduce the investor 'value-gap' between GM, Ford and (notionally) Chrysler versus the rest of the world's automakers, especially so the 'hi-performance' Germans.

For Q1 2011, BMW, Daimler & VW. BMW proving yet again that its profitability margin at 11.9% outstrips all western VMs, VW Group's Audi division reaching a still impressive 10.9% and Daimler hitting 9.3%. Thus, for investors the decades long value-chasm between US & Germany automakers (Opel within GM) appears as real as ever.

However, a brief look at Detroit's Q1 results would be instructive to gain closer view :

General Motors :

GM saw its fifth consecutive profitable quarter with Q1 profit triple to $3.2bn from a revenue of $36.2bn (from $31.5bn in Q1 2010). EBIT improved to $3.5bn (vs $1.8bn), but had a hard reduction hit from special items of $-1.5bn (vs $-0.1bn), leaving an Adjusted EBIT of $2.0bn (vs $1.7bn), the impact of special items on EPS dilution being $0.82 (vs $0.08). Thus the notional top-line $1.77 dividend figure (vs $0.55) was effectively halved. Automotive net cash flow from operating activities weakened to $-0.6bn (vs $1.9bn), whilst Automotive FCF dropped to $-1.9bn (vs $1.0 a year earlier), both cash-flow lines hit by the $-2.5bn termination cost of previously agreed wholesale financing packages.

North America (GMNA) reported EBIT of $2.9bn (vs $1.2 bn), on an EBIT-adjusted basis, GMNA increased earnings to $1.3bn (vs $1.2bn), the remainder of 2011 expected to see EBIT-adjusted results improve due to better pricing and fixed cost reductions offsetting commodity cost increases and unfavorable mix. Europe (GME) EBIT of $-0.4bn (vs $-1bn) showed improvement but still a loss, targeting to achieve EBIT-adjusted break-even basis before restructuring for FY2011.
International Operations (GMIO) EBIT of $0.5 billion (vs $0.9bn), with EBIT-adjusted $0.6bn (vs $0.9bn). South America (GMSA) EBIT of $0.1 billion (vs $0.3bn) with no adjustments in either period.

The American re-bound then continues, GM a beneficiary with its NA market share climbing slightly from 2010's Q1 of 18.7% to 2011's Q1 of 19.6%, April seeing 20.1%. Yet that market-share was effectively bought with greater purchase incentives than its two cross-town rivals, GM offering an average of $3,313 in discount/'throw-ins' as an avarage throughout the 2010/11 period, the greatest 'value-destruction' per unit amongst the rivals. For a company supposedly offering a strong vehicle portfolio and changed ways, this does not look good; even if it states that from April onward incentives have dropped by 8% it still leads the pack in terms of vehicle give-aways to fill production capacity.

GM expects that full-year 2011 EBIT-adjusted results will show solid improvement over 2010. GM continues to expect no material impact on full-year results from the Japan crisis. For the quarter, automotive cash flow from operating activities was $(0.6) billion and automotive free cash flow was $(1.9) billion. Both figures include the $2.5 billion cash impact of GM’s decision, announced in October 2010, to end a wholesale advance agreement with Ally Financial.

GM ended the quarter with very strong total liquidity of $36.5 billion. Automotive cash and marketable securities, including Canadian Health Care Trust restricted cash, was $30.6 billion compared with $27.6 billion at the end of the fourth quarter of 2010.

However, much of that $ 3.2bn profitability figure was gained from sales of stakes in former affiliates, an important point at a time when the lion's share of bookable profitability should be derived from vehicle sales and margins there-on.

investment-auto-motives was critical of GM at the time, since its actions to 'window-dress' prior to the IPO appeared drastic, using 'old-culture GM' short term tactics to boost company growth and so valuation. Its pre-IPO 'turnaround' went beyond conservative operational measures, the prime example being the leverage of sub-prime lending to 'top-up' income, easily bookable 2-stream profitability derived from the additional unit sales of cars / trucks and the loan-book effect of higher APR rates derived from higher-risk lending.

Like the US administration's massive QE programmes that propped up the country's economy at such cost, the executives at GM & Chrysler no doubt view “the past (as) another country”, the 'ends' of a more stable country and its 'domestic' corporations justified by the 'means'; looking forward the critical action, not dissecting the recent past.

But, it was one of the danger signs which under-pinned investment-auto-motive's suspicion that the post IPO share-price in the near term would 'flat-line' at thereabouts its $33 launch price. This has proven the case 5 months after the November re-listing, the price wavering seen in the interim between $29 & $39 due to market over-reaction.

Ford Motor Co :

Q1 2011 net income was $2.6 billion from a total revenue of $33.1bn (vs $28.1bn in Q1 2010) so up $5bn. Thus gave an EPS of $0.61, a $466m YoY increase. Pre-tax operating profit was $2.8bn or $0.62 cents per share, an increase of $827m YoY. The company showing a pre-tax operating profit over the last seven consecutive quarters.
Of this, the Automotive division pre-tax operating profit was $2.1bn , an increase of $936m YoY; whilst the Finance division saw a pre-tax operating profit of $713m, a decrease of $-115m YOY.

Automotive operating-related cash flow reached $2.2bn, a YoY improvement of $2.3 bn, with Automotive gross cash of $21.3bn, up $800 m compared to FY2010-end. Automotive gross cash exceeded debt by $4.7bn, up by $3.3bn from FY2010-end. By Q1 2011 end $30.7 bn was held in total Automotive liquidity, an increase of $2.8bn over the preceding quarter. Automotive debt was reduced by $2.5 bn of net reductions, this resulting from redemption of all outstanding Trust Preferred Securities.
For full year results, Ford plans to deliver continued improvement in pre-tax operating profit and Automotive operating-related cash flow compared to 2010.
FoMoCo's average NA discounting expenditure was $2,878 in 2010/11, the lowest of the Big 3., highlighting its standing in the public's eye as America's most credible of US auto-manufacturers.

It also reflects good model mix management, and the leverage to competitively price vehicles thanks to scale efficiencies created by its sector lead in global platform/module engineering Moreover, its maintained focus on general internal cost-control and fixed and variable levels.

But ultimately demonstrates the most harmoniuos alignment of brand personality, product quality, RRP levels & 3-year vehicle residual value.

That figure set to decline by 20% in Q2 2011 onward, to $2,399, which whilst still unwelcome - representing as it does approximately 15% of a typical vehicle's 'sticker' value - demonstrates Ford's willingness to resist very-heavy discounting, its F-series pick-up as ever leading its class and retains #1 rank in overall sales, and its small & compact cars, far lower down the sales ranks defended from the very damaging margin erosion typical in small cars sales.. Thus the blue oval demonstrates both good internal practices and maintains consumer credibility, extremely useful when re-building its product-line to in turn grow unit and business margins.

The only concern is that with Focus sales down 6% in April, reflecting the models run-out and renewal, that self-discipline, amongst dealers at least, may be severely tested, and retaining RRP pricing on new 2012 (Q2 2011) Focus will be a Ford 'must do'.

Chrysler Group LLC:

Chrysler reported its first positive income statement in Q1 since its restructuring in June 2009. Net Revenues $13.1 billion (vs $9.7 billion in Q1 2010), a Modified EBITDA of $1.171bn equal to 8.9% (vs $787m), a Modified Operating Profit of $477m equal to 3.6% of Net Revenues (vs $143m), Net Income of $116m in Q1 2011 ( vs $-197m in Q1 2010), with Cash at Q1-end at $9.9 billion, (vs $7.4bn at FY2010-end), FCF at $2.5bn (vs $1.6bn) improved accordingly. Gross Industrial Debt was $13.3 bn (vs $13.1bn at FY2010-end), Net Industrial Debt of $3.4 billion showed a decrease (vs $5.8bn billion at FY2010-end), primarily due to the increase in cash.

Yet each reporting line had a notation caveat, and critically the Gross Revenue line was not included

Its US market share increased slightly to 9.2% vs 9.1% a year earlier; with Canada gaining 1% to 15.7%. Worldwide sales in grew 18% YoY to 394k units. In contrast, worldwide vehicle shipments grew by 28% to 485k in Q1 (vs 380k in Q1 2010). This difference in sales versus shipments growth figures highlights the possibility that Chrysler has intentionally over-stocked its international dealers to both realise early shipped income (via full or part-payments) and to demonstrate to foreign consumers that Chrysler & Jeep are once again 'fully-fledged' operators.

Chrysler also discounted its vehicles averaging $3,451 in give-aways during 2010/11, less than GM but still appreciably more than Ford, its intention to reduce that figure by 23% to $2,806 after Q1

As a precursor to its intended IPO, Chrysler submitted Form 10 disclosure to the SEC highlighting its performance as an LLC status company bound under Federal agreements to pass specific financial, operating and product milestones. The milestones enabling the uptake of increased shareholding call-options, the second of these milestones now passed, so able to increase share from initial 25% to 30% (after phase 1) to 46% (presently) and onward to a final 51% at milestone 3, expected in Q4 2011.

As the smallest US automaker Chrysler has also perhaps both the greatest challenge and also opportunity for growth. Its best selling vehicle is the Dodge Ram pick-up, but it only sits at #15 in the April sales rankings, whilst its direct rivals the F-series and Silverado sit in #1 and #3 spots respectively. Irrefutable then, that new product pipe-line must be wholly compelling across all 3 group brands, and throughout each's pricing ladder.

The company's reporting of being 'back in the black' was expected by the markets, but its parent FIAT Auto SpA (now seperated from FIAT Industrial SpA) is experiencing problems. Despite Fiat Auto SpA has reporting Q1 revenue of €9,210m (up 7.1% from the Q1 2010), disproportionate out-performance contribution by its components division, earnings in Fiat's Automobiles business declined by €4m YoY with Fiat Group Automobiles (FGA) seeing trading profit dip by 15.0% and the margin easing to 1.9% from 2.2%. Leaving a FIAT SpA margin of 2.7%, the same as Q1 2010.

Thus the FIAT parent has its owns woes to combat, an aged product-mix in passenger cars – still awaiting New Uno – and internal cost rises depleting what should have been a 3.0+% margin. The FIAT board then is has the task of dual (yet merged) companies resuscitation and brands and product stories which have yet to convince US consumers.


Detroit's 3 have had a fortuitous Q1 and April in its homeland market.

GM sold 25% more vehicles by April 2011 than a year earlier, reaching 825,100 units YTD in 2011. Ford sold 16% more vehicles YoY, reaching 684,800 units. Chrysler sold 22.5% more vehicles YoY, reaching 404,175 units.

This primarily down to 5 factors.

Firstly, The Federal Reserve's Keynsian derived QE2 programme replaced QE1 to 'keeping America moving' and so general confidence in the immediate financial framework and its synergistic effect on a 'Restructured Detroit' was prevelant.

Secondly, domestic demand stayed relatively buoyant even after repeal of the financial aid packages Washington presented to smaller car buyers, the success of Wall St and general corporate earnings through 2010 inferring that economic normality was on its way, and so the consumer (without house-purchase expectations in a dour housing market) was able to spend on personal items, just as fleets were able to replace cars at welcome discount rates.

Thirdly, the still deflated dollar on a global stage allowed GM, Ford & Chrysler to ship large numbers of vehicles to foreign shores, the shipments a mix of leisure-orientated status product destined for buoyant EM countries, such as Jeeps for Russia, and commercial vehicles in the form of pick-up trucks to industrial customers in CIS, Middle East, Latin America etc, alongside the sales prospects the likes of Caterpillar achieved serving national infrastructure and primary industry projects..

Fourthly, the $ vs Won FX 'chasm' meant that the recently hugely US successful Hyundai Motor had less leeway to price-compete on US shores, itself under pressure in Asian capital markets to maintain margins relative to the pressure from its industrial conglomerate peers in S.Korea and elsewhere. Thus the tables in its competitive US fortunes were turned, though it still managed to

Fifthly, Detroit enjoyed a great macro-propelled competitive-advantage created by Japan's national disaster, massively undermining Japanese VM & supplier production centres, seeing Japanese domestic demand hit hard, aswell as the inability to service other Asian & American assembly plants; deliveries not expected to return to normal until June-August.

Thus Q1 was a kind of 'perfect storm' of advantage for GM, Ford and Chrysler, yet given the tailwinds prevalent analysts are asking what happened to investor returns?

It points to a general attitudinal relaxation by US VMs on their own internal cost-bases – perhaps especially so in procurement and marketing – aswell as general overhead cost-absorption such as executive travel and IT expenditures.

Beyond long-term debt being paid down to reduce future cash-flow drag - encountered by higher inflation rates and so payable interest - it appears that income is being hived away in reserve pots for latter day deployment.

In veru generalistic terms, excluding immediate and long-term liabilities, GM holds a $36.5bn liquidity pot, Ford a $30.7bn pot and FIAT a $20.18bn* (E14.1bn*)pot partly accessible to Chrysler)[NB *inc recent bond sale income].

Given this early stage of the economic cycle the first substantive impression is that the funds are to be used for strategically aligned 'bolt-on' acquisitions. Unlike the 1990s when auto-makers sought to build their brand and product portfolios, today the imperitaive is to re-build presence across the value-chain in specific areas of technology supply and retail / distribution.

Thus VMs will be seeking Tier 1s and 2s with specific ability to bolster in-house brands ideally with target region presence. Thus providing a formula which can leverage both regional market growth for enhanced volumes and margins, the automaker as parent shareholder thus enjoying additional synergistic income streams at both a cash level from dividends and at long-term asset level on its own balance sheet. But as importantly able to effectively dictate business terms with higher rate pricing discounts than would otherwise be the case, having to then balance the profitability levels of parent and child.

However, beyond this pertinent consideration, those reserve pots will also very probably be deployed to meet the future renewed challenge from Japanese, Korean and European producers, as their own headwinds decline. Japanese production normalisation, and a reduced FX spread between the $ and Won & Euro will certainly create a tougher environment for Detroit.

Inevitably, the new influx of foreign competition will come, at which point Detroit looks prepared to return to its old game of massive advertising programmes, heavy discounting and feature & accessory give-aways.

On its home-ground, beyond M&A activities, there is a good chance that the supposed 'New Detroit' may well end-up acting suspiciously like the 'Old Detroit'; simply throwing cash at the problem by effectively buying market share, and so reducing its unit margins and ROI.

With a likelihood that the recent decline of vehicle purchase incentivisation programmes will indeed reverse in the face of the expected foreign challenge, the stewards of both long-term investment funds and long-horizon hedge funds should maintain a beady eye upon the US auto-maker's margins, and its net payable dividends.
For its is only this that will properly support Detroit's innate value and market capitalisation levels.

Far from being confrontational, a new generation of more activist stewards would simply be new era governors, replacing the 'save and support' mindset of Washington's governorship with one better attuned to commercial and investment reality on the global stage.

In the meantime, GM, Ford & Chrysler must do all they can to leverage the improvement in public sentiment given the good news which recently eminated from the White House. That means honourable, not crass, message campaigns, since Detroit's US and global renewal also carries the responsibility of reflecting America's outward persona.

Those bumper-stickers offering bin Laden jokes are best left at the dollar-shop.