Why a UAW Deal Could Power Auto Stocks

S&P believes the contract should reduce labor costs and boost profits of automakers over the deal's expected four-year life

General Motors (GM; $30) and Ford (F; $8) are in contract negotiations with the United Auto Workers, and a contract could be signed soon after the Sept. 14 expiration.

According to a wire-service report, the union has named GM its lead company, which means it will negotiate a new contract with GM and then ask Ford and Chrysler to accept the same terms. GM's lead company status also means if there is a strike, its plants will be targeted.

Efraim Levy, senior automotive equity analyst for Standard & Poor's, believes the contract should significantly lower labor-related costs and enhance the annual profitability of automakers over the expected four-year contract duration.

One reason comes down to health-care costs, which have been hurting the automakers for years. Levy believes the contract could establish a VEBA (Voluntary Employee Benefit Assn.) health-care fund. This move would, in Levy's opinion, remove a major liability and annual expense for the automakers. However, expected benefits are partly reduced by the immediate costs to fund the VEBA and the reduced liquidity at the companies.

Increased Financial Strength

Levy notes the reduced health-care costs that are likely to be brought about by this contract could lead to increased financial strength for the automakers, which, we think would lead to lower interest costs.

"Ultimately we need to see progress on the product side of the automakers' businesses, or else they risk continuing the cycle of further production cuts and layoffs," Levy says. "Despite the expected sizable annual savings from health care and other cost reductions via contract negotiations, the companies are still struggling to improve volume and market share and to establish sustained profitability. Thus, our opinion on the shares remains hold."

Turning his thoughts to product development, Levy says both GM and Ford need to manufacture and sell products that consumers want to buy without the need to sell "the deal." For example, GM is selling the Buick Enclave and GMC Acadia crossover utilities with minimal incentives, because of the products' inherent attractiveness.

"The companies need more of these," says Levy. "Occasional hits are not enough, especially when domestic brand profit centers such as pickups and sport-utility vehicles are under attack from Toyota's (TM; $113) Tundra, weak housing markets, and higher gas prices."

Toyota, like Ford and GM, carries a 3 STARS (hold) ranking from S&P.

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