GM and Ford: Timelines for Turnaround

S&P doesn't factor a work stoppage into its ratings for the carmakers, but 2007 contract talks will probably reflect recent challenges

From Standard & Poor's RatingsDirect

The road continues to get bumpier for U.S. auto makers General Motors (GM; S&P credit rating, B) and Ford Motor (F; BB-). They're facing operational and financial challenges as never before in their North American divisions. Revenue shortfalls -- stemming most recently from an adverse shift in product mix, in addition to excess capacity and legacy costs relative to current market share levels -- remain at the heart of the problem.

Both companies' performance outside the U.S., including GM's significant share in growing markets such as China, doesn't begin to offset the poor performance in North America.

Time is short to remedy these issues. In the next 18 months -- leading up to crucial labor negotiations -- both companies must demonstrate progress in turning around their North American operations to significantly reverse recent negative financial trends (see BW Online, 3/14/06, "GM and Ford: Roadmaps for Recovery").


  If last year's trends persist, which Standard & Poor's Ratings Services doesn't necessarily believe will be the case, GM could ultimately have to restructure its debt and contractual obligations. This is in spite of GM's current substantial liquidity and management's statements that they expect improved financial results in 2006 and have no intention of filing for bankruptcy.

Many factors raise concerns about demand in 2006, among them still-high gasoline prices, rising interest rates, uncertain consumer confidence, lengthening auto loan terms, and a declining volume of cars coming off lease. Sales results in the first two months of 2006 don't provide enough information to forecast results for the entire year, but they seem to indicate that sales and inventory levels are perhaps in better balance than in the early part of 2005.

Nevertheless, preliminary second-quarter production schedules for GM and Ford are below 2005 levels. Market share declines continued in the first two months of 2006. We still expect that 2006 U.S. light-vehicle sales will be modestly below 2005 -- and that market share pressures on GM and Ford will continue.


  Market-share loss in North America isn't enough to explain the sharp decline in both companies' financial results during 2005, since it has been going on for several years. And the consistent drops have created a number of cost problems over the years, including the cost of JOBS -- a contractual mechanism that pays laid-off workers nearly full pay and benefits -- and restructuring costs even before 2005.

Industry sales were broadly favorable in 2005, and we currently expect 2006 to be roughly in line. The difference in 2005 compared to past years is that sales of GM's and Ford's most profitable products plummeted in 2005, as the SUV bubble burst. The drop in SUV sale highlighted the degree of overcapacity and excess structural costs inherent in the North American operations for both companies.

Ford's financial performance was somewhat less negative than GM's in 2005, but Ford faces the same fundamental requirement to reverse the decline in its North American results. Even so, while its still-substantial liquidity will continue to provide considerable protection against the risk of financial distress for the next few years, Ford is highly subject to the pricing actions of competitor GM and could suffer from any further turmoil there.


  Fixing the now clearly burdensome cost structure of both companies is paramount. These turnarounds will be difficult. Many consumers continue to perceive GM and Ford vehicles as lower quality than some objective measures show they really are. We believe changing this perception will be a multiyear process.

Regarding the cost base, both companies have begun to implement broad restructurings, but this will also be a multiyear process at best, and at least partially subject to the fall 2007 labor negotiations with the United Auto Workers (UAW).

Until those crucial labor contract negotiations, we expect that the ratings and financial fortunes of GM and Ford will be determined in large part by how their evolving vehicle product line-ups are accepted and in what sort of pricing environment, as well as how much progress they make on the extensive restructuring programs announced for their respective North American operations. The degree of success with these issues will determine cash-generation levels -- a key factor we're watching for both the GM and Ford ratings.


  We at S&P aren't anticipating any significant concessions from the UAW in advance of fall 2007 contract talks. While we would expect various announced cost reductions that aren't subject to UAW negotiations to begin to demonstrate net benefits during the latter part of 2006, some of the announced reductions will have to be incorporated in the new contract.

The coming contract renewal will therefore be crucial to implementing much of the cost savings that both companies have set forth in the latest round of North American restructuring plans. We expect management and labor to take hard-line positions given the precedent-setting issues that will be up for negotiation.

It's impossible to predict what the industry environment will be in the fall of 2007, but it wouldn't be surprising to see some sort of work stoppage during the negotiations because of what's at stake. We don't incorporate such a negative event into the current ratings of GM or Ford, and we aren't predicting that either side would prefer such an outcome.

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