A Rough Road Ahead for GM and Ford

GM's ratings could be lowered within the next year -- and Ford's within the next few years -- if things don't improve

On Feb. 6, Standard & Poor's revised its outlooks on the ratings of General Motors Corp. (GM ; A/Negative/A-1), Ford Motor Co. (F ; A/Negative/A-1), and related entities to negative from stable.

The outlook revisions reflect the rating agency's heightened concerns about the ability of these companies to maintain satisfactory financial performance over the next few years amid a likely cyclical downturn in the North American auto market, secular intensification of competition in their most profitable product segments, and continuing lackluster results at their overseas automotive operations. GM's ratings could be lowered within the next year, and Ford's within the next few years, if measures to mitigate these adverse factors are unsuccessful, and unless sufficient liquidity is retained to provide for ample near-term financial flexibility.

U.S. car and light truck sales reached a record 17.4 million units in 2000, but the past three months have seemingly marked the onset of a cyclical downturn. Slowing economic growth, deteriorating consumer confidence, and tighter consumer credit now seem to be playing a role in depressing demand, as does the long duration of the previous sales boom. Industry sales in 2001 will likely be in the range of 15.5 million to 16.0 million units. By historical standards, this would still represent robust volume. But, profit margins at GM and Ford have already come under pressure, reflecting in part the effect of heavy sales incentives.

Pressure on margins could well increase. During the past decade, a highly disproportionate share of GM's and Ford's earnings has been derived from sport utility vehicles and pickups. The secular growth in these product segments is expected to slow, however, while a surge in new product introductions--by competitors and, to some extent, by Ford and GM themselves--and accompanying expansions of production capacity will likely dilute the highly favorable supply/demand conditions that have given rise to the premium profitability enjoyed until now. In the face of these challenges, GM and Ford are seeking to define new vehicle segments with their so-called "crossover" vehicles that blur the distinctions between traditional vehicle types. But, the appeal of such products for American consumers is largely untested.

GM and Ford are also accelerating their cost-cutting initiatives. Their automotive finance operations should remain highly profitable, even taking account of a likely rise in credit and lease residual losses.

Their international automotive operations presently are not meaningful contributors to earnings or cash flow. Although demand in Europe weakened in 2000 -- to 14.8 million units, down from a record 15.1 million in 1999 -- it remains strong. But, price competition has been even more intense there than in North America. Profitability has been weak industrywide, and due to a host of company-specific factors, Ford and GM are underperforming most of their Europe-based peers. Demand in Latin America remains depressed: the precipitous sales decline in Argentina in the past year has largely offset the benefits of slight sales recovery in Brazil. Moreover, since the mid-1990s, GM and Ford have divested most of their major nonautomotive businesses.

Although GM and Ford continue to enjoy above-average financial flexibility, their most ready source of flexibility-–their holdings of cash and equivalents-–has diminished as a result of acquisitions and distributions to shareholders.

The situation at Germany-based DaimlerChrysler AG (DCX )is more acute than at Ford and GM. Plummeting sales have led to massive losses and negative cash flow at DailmerChrysler's Chrysler division since mid-2000, while a series of aggressive acquisitions and investments has significantly eroded DaimlerChrylser's financial resources. DaimlerChrysler's long-term ratings were lowered on Dec. 4, 2000, to A/Negative/A-1 from A+/Watch Neg/A-1). On Feb. 26, DaimlerChrysler's management is scheduled to disclose further information about the turnaround strategy to be implemented at Chrysler. Standard & Poor's will assess this restructuring plan to determine if any further rating action is warranted.

From Standard & Poor's CreditWire

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