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General Motors & Ford-Its the cars Stupid¯ part I

When Bill Clinton ran for the Presidency in 1992, his platform was basically, its the economy Stupid¯. When we look at the state of the American automobile industry, we believe both companies are on the wrong track. General Motors stock bottomed at $17 per share, and is now trading in the $30s. Everybody is excited about chopping employees, closing plants, and potentially hooking up with Renaults formidable Carlos Ghosn. This is all financial engineering, which is great for what it is, but its not what car manufacturing is all about. Its all about cars, does anybody remember that GM, and Ford make cars.

What gets you into trouble is what has to get you out of trouble. The 25 year problem with American car companies, is that we manufacture cars that are less than desirable. Is anybody listening out there? If you look at sales patterns on the East coast, and West coast of the United States, you will see that Japanese manufacturers dominate both coasts in sales. The car companies are selling to long-time loyal Americans that buy American in the Midwest and Southeast. They are not selling on the basis of quality, and bang for the buck. They cant compete on that level.

The problem comes down to this. The Japanese companies have mastered zero defect manufacturing. This means the car comes off the assembly line perfect. There are no (zero) problems to be fixed at the dealer level. When a person takes delivery from the showroom, he rides out with a car that doesnt have to come back until the first major service. The reason why so many Japanese companies have instituted free oil changes on their vehicles is because the cars run like toasters. They run for tens of thousands of miles with nothing going wrong. People were not even changing their oil, so if most cars were leased, the companies had to make sure that at least the oil got changed. Cars are designed for the first buyer, to have zero problems, and the Japanese have mastered this.

Contrast this management decision with Detroits way of thinking. The cars go into the showrooms with defects. Detroit has made a conscious decision to fix these problems after the customer takes delivery. The customer will then bring the car back with a list of problems, and fix it at the dealer level. There is no comparison between consumer satisfaction with domestic cars, versus Japanese cars.

The Chairman of General Motors is a throwback to an age that no longer exists. Einstein said, We cant solve problems by using the same kind of thinking we used when we created them.¯ This is what we are experiencing at GM, and Ford. William Clay Ford Junior, the current Chairman of Ford has done restructuring after restructuring to no avail. Ford is still losing market share. What about market share, Bill?Every time GM loses a point of market share, they create for themselves an additional $1.4 billion in pretax losses. Our work shows that the automobile industry may be sliding into recession in 2007, and then where is this industry going to find itself? Lets take a look.

Last year in 2005 if you look at GMs automobile operations as a standalone business, they went through almost $7 billion dollars. This year aside from restructuring costs, we think they burn another $4 billion, plus $4.5 billion in 2007. The announced restructuring only amounts to $4.5 billion in savings. They are still bleeding, they are still losing market share. Over the next couple of years, you have to add upwards of $900 per car for raw materials, and costs imposed by Washington regulators, and GM isnt alone. Ford will burn through $4 billion this year, and almost $4.5 billion next year in 2007. How do these guys keep their jobs?For GM we cant see where what they save from restructurings which is $4.5 billion in cash can offset the cash burn rate they have created. They are still hemorrhaging cash while LOSING MARKET SHARE. Do you have any idea how tough it is to turn around a gigantic company like either of these companies while they are still losing market share. It would be tough to do it in a fabulous economic environment.

Lets look at two points here. The first is when you break down the automobile companies by divisions; GM and Ford make a lot of money from selling light trucks. GM by itself made almost $1.5 billion income last year from this division. The year before that, they made twice as much. We see this division taking a real hit next year for both GM and Ford. Gas prices are going to wreak havoc with the sales of these vehicles, and housing starts will be down. Look at the homebuilding stocks and their declining prices (more like an avalanche), and you will see where housing is going next year. Huge numbers of these trucks are sold to people in the construction industry. Figure it out for yourself.

Whats going to happen is this. Quickly, GM and Ford are going to have to start selling passenger cars, and what you call crossover vehicles. They are going to get clobbered. The Japanese get between $900 and $3800 more per passenger car than the guys in Detroit. This means the Japanese care are loaded down with extras that we just cant put in our American built cars. This segment includes SUVs.

We are looking for 16.

8 million cars to be sold in the United States this year 2006. Contrary to what GM and Ford believe, we think next year is down a couple of hundred thousand cars, and neither of these companies is budgeting for that experience. Housing prices in this country are sideways to down. People will not be extracting cash from their houses in the form of home equity loans to be buying cars next year. They will not be feeling good about the price of their house, and therefore consumer sentiment will suffer. The first hint as to whether we are right will be if there is a Democratic watershed coming in the Congressional elections this November. If the Democrats take control of either chamber of the Congress, it will be prelude to a down automotive cycle in 07. That will be your indicator. Watch for it.

Goodbye and good luckRichard C. StoyeckAugust 1, 2006

About The Author Richard StoyeckĆ¢ā‚¬ā„¢s background includes being a limited partner at Bear Stearns, Senior VP at Lehman Brothers, Kuhn Loeb, Arthur Andersen, and KPMG. Educated at Pace University, NYU, and Harvard University, today he runs Rockefeller Capital Partners and StocksAtBottom.com
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