By Martin Hutchinson
Back in the 1960s, when it was still one of the best companies in the world, Ford Motor Co. (NYSE: F) used its familiar marketing mantra to tell its customers that "we bring you better ideas."
By opting to go it alone – and eschewing the constraining government support that's likely to relegate U.S. peers Chrysler LLC and General Motors Corp. (NYSE: GM) to bankruptcy's death by a thousand cuts – Ford is returning to its roots and demonstrating that it once again has that "better idea."
Chrysler has already been forced into Chapter 11 bankruptcy and – armed with $11 billion in government aide – is being reorganized by the Obama administration with help from Italy's Fiat SpA (OTC ADR: FIATY).
GM is inching towards a similar fate as it struggles to turn its business around with $27 billion in government aid.
For investors, there is only one moral to this sorry tale: Of Detroit's so-called "Big Three," the only one worth looking at is Ford.
And here's why.
Chrysler's business plan doesn't make a lot of sense. Fiat – itself rescued from a near-death experience only a few years ago – is an Italian maker of small cars that pulled out of the U.S. market in 1984 because of quality problems so severe that its market share evaporated. Because of its small-car orientation, it is favored by the Obama administration and by environmentalists, but there is no reason to suppose that U.S. consumers' tastes have changed so much that Fiat-designed cars, manufactured in high-cost U.S. plants, will have much appeal.
Yes, the United States now contains many immigrants from Latin American countries, where Fiat is strong, but there were good reasons they emigrated from Latin America, and one of the major ones was the hope that they wouldn't have to drive Fiats forever.
Of course, the government and the United Auto Workers (UAW) union will jointly control the new Chrysler, and will therefore have considerable influence on the kinds of cars it produces. But I'm not sure that should give us much confidence.
Naturally, if the new "cap-and-trade" costs make gasoline much more expensive, U.S. consumers will presumably migrate to smaller cars, but even if they do, I don't know why they should not migrate to Asian ones, as they have already done for the last three decades.
GM is a somewhat different proposition, whether it goes through a formal Chapter 11 bankruptcy or not – which we'll know by the end of this month. Unlike Chrysler, GM has a full product development capability and has scored some major successes internationally.
For instance, Buick is still a leading brand in the China market, where GM's market share increased from 12.5% to 13.7% in the first quarter of 2009. Furthermore, unlike Chrysler, GM has a full range of products, and is large enough to remain competitive globally – if provided with operating capital.
Nevertheless, GM is losing money at a frightening speed. The company lost only $6 billion in the first quarter of 2009 (sounds like a lot, but the company has lost an aggregate $88 billion since 2006), but it managed to burn through $10.2 billion of cash. To burn through $4 billion of cash above your book loss – in a quarter when sales were exceptionally low – suggests that demand for your products has fallen off a cliff, and that you are producing purely for inventory.
It's not as if the company's piling money into capital investment.
With an average cash drain of $10 billion a quarter, GM's $27 billion capital from the federal government will last less than a year. Furthermore, if the government's plan is adopted, it will be majority owned by the U.S. government and the UAW. That is unlikely to give it either a decent product lineup or a workable cost structure. I don't know about you, but by and large, the types of cars the political classes want me to buy aren't the ones I want to drive.
I suspect that's true for the vast majority of U.S. consumers – and the ones for which it isn't true are already driving imports of one sort or another.
And that leaves us with Ford.
When Ford refused to take government aid back in December, it looked an eccentric decision. Everyone knew Ford was losing billions, too, and the fact that it had raised huge amounts of debt in 2006 to give itself a fighting fund only seemed likely to delay the inevitable bankruptcy or federal cash infusion. Five months later, after the conditions attached to the GM and Chrysler cash injections have become clear, Ford's decision is much more comprehensible – and perhaps even shrewd.
The question is: Can it make the decision stick?
Ford's results for the first quarter of 2009 were significantly better than those of GM. It lost only $1.8 billion; more importantly, its cash outflow was only $3.2 billion – despite capital spending that was $300 million greater than depreciation. With $21 billion in cash, Ford can survive for at least a year at that rate without any danger of running out of cash.
Given that I rather expect a U-shaped recession, with a very slow recovery (even though we are currently nearing the bottom), if all other things were equal that might not be quite good enough. Running out of cash in June 2010 – before sales have picked up – does not give you any measurable strategic advantage over running out of cash in June 2009, as GM is about to do. Presumably, the unpleasant features of a government/UAW takeover would be just as unpleasant next year as they are today; after all, the same guys will still be in control, politically speaking.
However, there is one very important variable. That is the bankruptcy/takeover of GM and Chrysler. I think consumers will only be moderately concerned about service, warranty, or replacement-parts issues with a bankrupt automaker, and only the silliest ideologues would resist buying GM and Chrysler products just because the government and the UAW control the companies.
But if you combine the effects on product line and quality of government/UAW ownership with a good Ford advertising campaign, you may see a different picture. In the year to date, the big three domestic manufacturers had 44.4% of the U.S. market. Since the product characteristics of U.S. automobiles differ from those of imported automobiles, it's likely that the market share of U.S. automobiles is unlikely to be eroded quickly, provided manufacturers are still making the products that those consumers prefer. However, if the government is mandating product lines at GM and Chrysler, it will push those companies increasingly towards smaller cars, and otherwise away from the characteristics preferred by domestic-automobile consumers.
Because Ford is able to operate much more freely, it is likely that the company will be able to pick up market share from GM and Chrysler in the domestic-auto market. In the last year, Ford has already increased its share of the U.S. auto market to 32.8% from 30.7%, even as the Big Three's share of the U.S. auto market as a whole has continued declining from 49% to 44%. After the GM and Chrysler restructuring, when Ford has become established as the only privately controlled domestic-automobile manufacturer, its market share may pick up considerably.
In other words, when I replace my ancient Buick about two years from now, it's more likely to be with a Lincoln than with another Buick or a Toyota. I'm a lousy automobile consumer (buy used, and keep them too long), but I'll bet in this respect there are lots of new car buyers who think like me.
If there are, Ford will pick up market share from GM and Chrysler, even if domestic brands overall continue to see their market share ebb. That will reduce Ford's losses, and when the automobile market does rebound, the company that created the original automobile assembly line will move to a position of substantial profitability. For the first time since Henry Ford kept the Model T in production too long in the 1920s, Ford may become the dominant U.S.-controlled automobile manufacturer.
Given its losses and all the uncertainty surrounding the sector and the overall economy, I wouldn't put a lot of money into Ford shares. But at $6 to $7 per share, it might be worth a speculative flutter.
[Editor's Note: Ford Motor Co. (NYSE: F) late yesterday (Monday) announced plans to sell 300 million common shares, and said it would use the proceeds from the offering for "general corporate purposes, and to make a contribution to a fund that pays for healthcare for its retirees. Ford Chief Executive Alan R. Mulally took advantage of that opportunity to say that Ford's management and employees are making "strong progress on our transformation plan – gaining retail market share with great new products, improving quality, reducing costs and positioning Ford for a return to profitability." Citigroup Inc. (NYSE: C), Goldman Sachs Group Inc. (NYSE: GS), JPMorgan Chase & Co. (NYSE: JPM) and Morgan Stanley (NYSE: MS) are acting as joint managers for the stock offering.
Money Morning Contributing Editor Martin Hutchinson is also the editor of the brand new "Permanent Wealth Investor" service. Look for more information on that service in the days to come.]
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