Fitch Predicts Bleak Outlook for U.S. Auto Companies
CHICAGO — Offering its take on what the auto industry can expect in 2009, Fitch Ratings reported this week that sales are expected to decline by about 10.7 percent from 2008.
Playing a part in this decline is the "rationing of credit" by the financing arms of the Big 3 to the highest quality borrowers, in addition to a tighter lending strategy by alternative financing providers. Fitch believes that these pullbacks will reduce "industry sales to a level even below actual demand."
Also taking roles in the further downswing of sales are the deepening U.S. recession and continuing impact of the credit crisis. Overall, Fitch forecasts that the 2009 sales volume will come in at 11.6 million light vehicles, compared with an estimated 13 million for 2008.
"The first half of 2009 is expected to absorb the brunt of this decline, with a sharp decline of 25 percent to 30 percent from 2008 levels, with the second half producing flat to modestly higher sales levels in comparison with second-half 2008 recessionary levels," officials explained.
The company also expects domestic fleet sales to decline further in 2009 as a result of reduced volumes from daily rental and corporate fleets, in addition to pressures on state and municipal budgets.
"The peak-to-trough industry sales decline of approximately 35 percent is expected to exceed the downturn of the early 1980s," Fitch pointed out.
The moves by the federal government to support financial institutions and to improve market liquidity may assist retail financing availability for consumer segments where demand exists.
On the other hand, the company explained that high unemployment and weak economic conditions will likely "mute any material recovery in industry volumes until well into 2010."
Furthermore, the global downturn will probably lead the international operations of Ford and General Motors to be hit with increased pressure, which will reduce the potential for cash repatriation and increasing the likelihood of operating losses in certain regions, executives stated.
"The recent operating, financial and product plans put forward by the automakers highlight a number of challenges that will shape the prospects of the Detroit 3 in 2009 and 2010," Fitch noted. "The role of the UAW is a key one, and is expected by Fitch to focus largely on the terms of the recent VEBA health care agreement, rather than wage rates. The original intent of the VEBA agreement — to separate the financing of health care benefits for retirees from the fate of the manufacturers — was not achieved due to the high component of debt issued by Ford and GM to finance the trusts.
"The UAW's willingness to defer VEBA financing obligations of the manufacturers indicates that the timing and amount of these payments is expected to be a major negotiating point, one in which the federal government could also play a role. This also emphasizes the clear incentive for the UAW to continue negotiating wage and benefit agreements outside of bankruptcy," the company said.
The likely benefits for the automakers from the two-tier wage agreement have not yet been seen, and Fitch reported that modest direct wage reductions, even if achievable through negotiations, will "not materially change the automakers' cost profiles."
The company went on to explain that benchmark wage and benefit rates in the industry have recently been established in the bankruptcy court (for Dana and Delphi), and have been extended to companies outside of bankruptcy (American Axle), indicating that wage pressures will certainly be on the table as part of a solution, in or out of bankruptcy.
"Although it appears that temporary government aid will be forthcoming for the Detroit 3, there remains much uncertainty regarding the amount, structure, timing and other terms of this assistance," officials highlighted. "Fitch has previously stated its view that if General Motors were to file for bankruptcy, industry revenue pressures resulting from the immediate GM price discounting that would occur, as well as the resulting cost and supply issues associated with turmoil in the supplier base, would force Ford to follow at some point thereafter."
However, the company pointed out that, "In the event of a Chrysler bankruptcy, liquidation is seen as the likely outcome, with a limited impact on industry pricing. Although a Chrysler bankruptcy would have repercussions throughout the supply base and on Ford and GM's costs and production schedule, it is unlikely that a Chrysler bankruptcy would produce the same chain reaction as would a GM bankruptcy."
Overall, Fitch said it believes that a bankruptcy at GM would result in widespread production shutdowns throughout the supplier base, which will likely threaten production at all U.S. auto assembly plants, including those of transplant manufacturers.
"At Sept. 30, 2008, Fitch estimates that GM and Ford had in excess of $21 billion in domestic, short-term trade payables, and the inability to make timely payments on any portion of these obligations would have crippling repercussions throughout the supply chain," executives stressed.
A possible catalyst of bankruptcy could be the inability or unwillingness of suppliers throughout the chain to supply trade credit to the Big 3, Fitch explained.
Due to the expected cuts in the auto production forecast for 2009, auto supplier operating performance and balance sheet deterioration will most likely continue to take place across the vast majority of the sector, with access to capital becoming even more restricted, according to the company.
"Suppliers are also becoming much more judicious in their willingness to invest in tooling and other product investment associated with new Detroit 3 product opportunities," Fitch stated.
Meanwhile, the company said, "Risks among the second- and third-tier suppliers are even more acute, as these suppliers are proportionately more exposed to production cuts at the Detroit 3 than the more diversified tier-one suppliers, and have little or no access to external capital. The supplier industry has already seen its share of disruptive bankruptcies (i.e., Collins & Aikman, Plastech), contract disputes, and other situations that have resulted in temporary production shutdowns, higher costs or various forms of financial support that ultimately accrue to the Detroit 3.
"Without question, these events will increase over the next several quarters. Restrictions on suppliers' ability to finance their operations through the sale of receivables of the Detroit 3 have further reduced access to external capital," executives noted.
Financial assistance from the Fed "would obviously improve liquidity" for those at risk; however, the extent of further capital structure improvement is unknown at this point, Fitch reported.
"As mentioned, the timing and amount of any VEBA funding is expected to be addressed, and could result in a reduction in these liabilities. In the case of pensions, the dramatic reduction in asset returns in 2008 will likely result in higher required contributions over the near term, but existing obligations are not expected to be a primary issue due to still-strong funded positions. GM, and to a lesser extent Ford, have been prudent in shifting their asset mix to a higher percentage of fixed income investments, which has served the companies and retirees well," officials highlighted.
Fitch went on to say it is not certain how GM's plan to reduce debt by half ($30 billion) could be reached successfully in a way where the threat of imminent bankruptcy is gone thanks in part to the provision of federal loans or loan guarantees.
"Over the longer term, reduced earnings and cash flow generation capacity at GM and Ford draw into question the companies' ability to support their current leveraged capital structures without a restructuring or significant new capital," according to the company.
Moreover, Fitch explained that, "Under the proposed terms of financial assistance to the Detroit 3, the role of the federal government in shaping the industry will be greatly enlarged. Direct governance, when combined with regulatory and legislative initiatives, indicates that government initiatives will play a major role in shaping and/or defining industry investment and demand over the near and long term.
"The list of topics that could have an impact is long — fuel taxes, gas-guzzler taxes, tax credits for fuel-efficient vehicles, federal and/or state emission standards, etc. — and is extensive. It will be interesting to note whether Ford, by seeking a standby facility rather than a direct cash infusion at this time, will seek to preserve flexibility by positioning itself outside of the government oversight terms and structure that are currently being discussed," the company pointed out.
Already at a competitive disadvantage, Fitch said the combined effects of the economic cycle and the credit crisis have further impaired the competitive position of the Detroit 3, compared to the import brands.
"Even though transplant manufacturers are also experiencing 30-percent-plus declines in monthly sales rates, the ability and willingness of transplant suppliers to offer zero-percent financing highlights the significant capital advantage enjoyed by these manufacturers — a competitive advantage that will translate into continued market share gains for the transplants in 2009," executives said.
"Over the longer term, capital constraints at the Detroit 3 have deferred product programs and will continue to restrict R&D/capital investment, which will clearly affect the companies' long-term competitive position during a period of rapid change in technology and product development," Fitch pointed out.
Looking at product investment, Fitch said there is little question that product plans will move more toward fuel-efficient, alternate-fuel and smaller vehicles.
"It remains to be seen whether the Detroit 3 can achieve an adequate return on investment across the broad spectrum of vehicles in smaller car segments given the lower price points, higher content, higher technology investment/costs and brand weakness," executives noted.
"Consumer demand for such vehicles, as well as their margin potential in an environment where gas prices have ranged between $1.50 and $4.50, remains an unknown. Although key details of Ford and GM's plans have not been made available, including such key details as what products are going to be produced in what locations, Ford's plan appears to be an acceleration of the product strategy and restructuring plan that have been well underway. On the other hand, GM's plan regarding a substantial portion of its brand, product, and manufacturing strategy appear to be still in formation. As a result, GM's plan is expected to require far more time and capital to complete than Ford's," the company explained.
While Fitch does see some positive things in the future, it said these will likely be overshadowed by economic weakness and industry risks:
"Lower commodity prices will reduce direct material (steel, in particular) and other indirect costs, savings that will be felt more materially in the second half of 2009. Falling gas prices will also improve consumer purchasing sentiment versus a $4 gas price scenario. In addition, Fitch believes that the pickup truck market, potentially experiencing a 45 percent to 50 percent peak-to-trough sales decline, could be reaching replacement demand levels. Pick-up volumes could also benefit in 2009 if material growth in infrastructure spending is enacted early in the new session of Congress.
"Despite the current focus on smaller, more fuel efficient vehicles, Fitch believes that pickup trucks will remain the primary driver in the ability of the Detroit 3 to stabilize operating performance and cash flows. Pick-up trucks are expected to remain a key 20 percent to 25 percent of deliveries at Ford and GM, even following the steep decline of the last several years, with contribution margins that remain at multiples of the remainder of the companies' product lineups. With more consolidated production in fewer plants and a reduced fixed-cost structure, any volume improvement in pick-ups will have a disproportionate benefit to consolidated operating performance," the company concluded.