So Much for Detroit's Cash Cushion

Acquisitions and stock buybacks have left carmakers strapped

Looks like hard times have really arrived for Detroit. True, U.S. auto sales have rebounded from their post-September 11 slump. They are now expected to top 16 million cars and trucks in 2001, making this one of the strongest years ever. But it took costly 0% financing to get sales out of the ditch. Such perks, along with slashed prices and bloated costs, have crushed third-quarter earnings for the Big Three, and they face an uphill battle to show profits in the quarters ahead.

What comes next could be even uglier: Analysts are projecting sales will fall off by at least a million vehicles next year--and the Big Three are heading into the downturn with cash reserves dropping sharply. If past recessions are any guide, that could mean problems. "They all had these huge cash reserves to weather the next crisis," says Christopher W. Cedergren, an auto consultant at Nextrend Inc. Now, "they don't have the financial ability to [develop] new product."

Of course, weak cash reserves in a downturn have always been the bane of the extremely cyclical auto industry. That's partly because of the huge fixed costs of running factories even through periods of low demand. But auto makers also need to build up enough liquidity to continue to fund the huge sums needed to come up with new models. During the recession of the early '90s, Merrill Lynch & Co. analyst John Casesa calculates that the Big Three burned through a whopping $28 billion in cash.

BROKEN VOW. This time around, things were supposed to be different. Years of restructuring in the early '90s put Detroit's auto makers on far stronger financial footing, and all swore they would be prepared for the next downturn. As recently as late 1998, both Ford Motor Co. (F ) and Chrysler Corp. (DCX ) had big cash cushions in their auto units. Excluding debt and prepaid employee benefits, Ford boasted net cash of $14 billion; Chrysler had $11.5 billion. Only General Motors Corp. (GM )--where net cash was already at -$1.2 billion--lagged.

With trouble now at the door, however, Detroit's piggy banks are again running low. In less than three years, the auto makers have drained nearly $30 billion in cash from their coffers. Ford added Volvo (VOLVY ) and Land Rover to its stable and paid out $3.5 billion for the Firestone tire recall. GM bought into Fiat (FIA ) and Saab. Likewise, DaimlerChrysler took a stake in Mitsubishi Motors Corp. and lost a bundle on troubled operations. Ford and GM, moreover, succumbed to investor pressure to return cash to shareholders through dividend increases and stock buybacks.

Now, shrinking profits caused by rising costs, big rebates, and 0% financing programs are making things worse. Ford lost $692 million in the third quarter, while GM lost $368 million; both earned over $800 million for the year-ago quarter. DaimlerChrysler got hit, too. Its profit fell 70%, to $821 million, in the third quarter, dragged down by Chrysler Group's $243 million loss.

PAYING THE BILLS. Money is already scarce. Ford has just $915 million in net cash. Merrill's Casesa estimates that if a downturn lasted three years, Ford could go through $11 billion in cash in net losses, capital spending, and dividends. Domestic rivals are worse off: GM is now down to net cash of -$2.3 billion. At DaimlerChrysler's industrial operations, net cash has dipped to -$4.1 billion.

Of course, that doesn't mean the bills won't get paid. In a tight spot, Ford and GM can each tap several billion set aside in prepaid retiree benefits. All of the carmakers can hit the debt markets, too. Ford raised $9.4 billion through bond sales on Oct. 22, although most will go to its financing arm.

Still, raising debt is getting pricier. One week earlier, Standard & Poor's cut bond ratings to BBB+ at GM and Ford. S&P is expected to cut DaimlerChrysler's rating as well. Ford is now paying almost a percentage point more in interest than last year.

Will the cash squeeze again force Motown to cut back on product development? In the recession a decade ago, high debt and faltering operations forced GM to delay a raft of new models. When sales took off again in 1992, GM was stuck with tired cars and a dearth of the newly popular SUVs. Rivals such as Ford grabbed market share with popular products like the Explorer.

That's an experience no carmaker wants to repeat. And Detroit already needs hot new cars and trucks to win back share from Asian and European rivals. With the cost of developing a new model now topping $800 million, though, the Big Three may have no choice but to cut back. "You'll see a lot of vehicles that were [supposed to be] coming out in 2004 coming out later," says Michael Robinet, managing director of auto researcher CSM Forecasting. That's not likely to make the cash situation any better in the long run, either.

By Kathleen Kerwin, with Joann Muller and David Welch in Detroit

Before it's here, it's on the Bloomberg Terminal.