3 Scenarios for The Future of the Auto Industry

There has been some pretty negative news surrounding the big three US auto manufacturers this year. Recently GM and Ford (F) reported continuing large losses, triggered by a decrease in the demand for cars nationwide. The demand for cars, which typically is highly cyclical in nature, is lower because of the low consumer confidence in the economy as well as the difficulty that car buyers have in obtaining credit financing to purchase new vehicles.

As a result of these events Detroit manufacturers’ stock prices have taken a large hit this year with GM losing 82% in 2008 while Ford stock lost only 70% during the same period of time. GM eliminated its dividend payment in July 2008 in order to boost its liquidity. The company has taken other measures to bolster its cash situation by selling off assets. Ford eliminated its dividend payments back in 2006. These two stocks should have been out of any dividend portfolio after the cuts, as every dividend investor knows that dividend cutters and eliminators have underperformed the stock market over the past 30 years on average.

The future of the US car companies is definitely getting bleaker every day. The executives of GM, Ford and Chrysler (DCX) are in talks to get money from the US government in order to keep the industry afloat until the current downturn ends. This could be the only thing that could save several million jobs in the auto industry, since selling off assets might be difficult to achieve in the current tough credit environment.

With GM and Ford stocks trading at multi-decade lows, it seems that investors could potentially make large gains once GM and F overcome the crisis and return to profitability. I see three scenarios for the future of car companies:

1. Car companies receive a loan guarantee from the US government, similar to the one received by Chrysler in the early 1980s. Millions of jobs will be saved; new energy and cost efficient models will be unveiled and after the economy recovers the auto manufacturers will make advance loan repayments and start paying out distributions to their shareholders. Furthermore, as long as the stock base isn’t diluted, long term investors could easily see large capital gains from current levels. Back in the late 1970’s Chrysler stock was trading at under $2 a share before the government loan guarantees. After the company turned around, the stock traded as high as $50 before the 1987 crash. No dividends paid for several years after the bailout. If this scenario were to occur owning stock would be a very good strategy.

2. The other scenario assumes that the US government entities does provide a bailout similar to FNM, FRE and AIG, where common and preferred stock ownership is diluted as the government takes majority stakes in the auto companies. This could lead to more losses for Ford and GM shareholders. The best strategy for this scenario would be to purchase GM and F debt at current levels.

3. A third scenario could occur if the government lets Ford and GM file for Chapter 11 reorganization. Shareholders will be completely wiped out, while bond holders would end up owning the companies after their interests are converted into equity into a newly formed corporate entity.

There could definitely be more scenarios involving a potential purchase of US assets by foreign auto manufacturers. The main point is that at this point owning GM or F stock is highly speculative, and should not be looked upon as an investment. In the meantime we could see short squeezes as short positions amount to 13% and 16% respectively of Ford and General Motors share float.
That being said if investors want to speculate on the auto industry, I believe that GM or Ford bonds could be the best vehicle for such operations. There are several retail bonds issued by GM, whose nominal value is $25. These bonds and notes are traded on the NYSE just like any other instrument. You could find more information in the table below (Source: GM Investor Relations Website):

 

 

 

 

 

 

 

 

 

 

 

 

 

 

Each of those bonds is trading currently at about 25% of face value.

Disclosure: None

Comments

[John D:]

The other part of the scenerio is that all of the profits from the auto industry would end up in foreign countries just like the profits from oil end up in the middle east - can North America actually afford to let yet another industry get wiped out of our economies ???? Next it will be the steel industry and so on and so on. A recent auto report links 1 out of every 10 jobs are directly related to the auto industry, can the governments afford not to offer financial assistance - even Canadian government has seen what the results would be and are in similar discussions !!!

2008 Nov 11 11:33 AM

[Tony C:]

The "1 job in 10" number assumes there would be no auto industry left in the US. False assumption. Americans will need as many cars as they ever have. It's just a question of who would build them, and where. Chrysler already builds most of its cars (not trucks) outside the US.

2008 Nov 11 03:58 PM

[33Nick:]

It would seem worse case scenario, that the companies would be sold off in pieces and bits. But that doesn't mean foreign investors would automatically want to buy a US based car factory. And what would be so wrong with it? Is it only normal if we invest abroad and not the other way around? Surely new blood wouldn't be bad in our car industry.

If the dollar keeps on going up, as it has, this would favor local VCs and investors and hopefully pull together new companies that are more adapted to modern demands.

Hopefully, the new startups and technology companies involved with electric cars and hybrids could pickup some parts of the big 3 and grow to replace our ill adapted cars.

There are many alternatives and I don't think we should concentrate on the worse cases. After all, many far reaching companies have been in this situation and we are still here as a nation. What comes up, will come down, and go up again.

2008 Nov 13 11:02 AM

[candooman:]

In addition, parts manufacturers supply not just one car manufacturer but several. So, GM going down does not mean all its parts suppliers go down with it. Example: Borg Warner supply brake parts to about 20 manufacturers and autoparts stores and will survive easily. Also, when GM or Ford declare Chapter 11, they will still produce cars, this time, models people want, and in volumes the market wants.


On Nov 11 03:58 PM Tony C wrote:

> The "1 job in 10" number assumes there would be no auto industry
> left in the US. False assumption. Americans will need as many cars
> as they ever have. It's just a question of who would build them,
> and where. Chrysler already builds most of its cars (not trucks)
> outside the US.

2008 Nov 13 04:04 PM

[derryl:]

Come hell or high water the US auto sector is not going into perdition. I would not put any skin into this game until the direction emerges because I am not a betting man, but betting against the Big 3 is a loser. I don't know how it will happen, but Detroit is going to be the NEXT BIG THING. I think it will be electrics, but there may be a meantime of gas/electric hybrids or natural gas engines.

Somebody, and it will be an American, is going to invent a revolutionary energy storage system that makes what we know as "batteries" obsolete. It may already exist in somebody's garage or in their head. Detroit, who already has the manufacturing capacity and dealer infrastructure in place, will buy the idea for a billion dollar song and commercialize it.

15 years from now you will be driving an electric car made in Detroit. Budget models will do 80 mph and cost under $15000. The Tesla can already do 125 mph. You will gas up by plugging into the electrical outlet on your house.

This is not science fiction. This is what is going to happen next. If anyone had told me 20 years ago that there would be a major new market for a device that played songs and showed video on a 2" screen I would have said they were delusional. And I would have missed out on a billion dollar opportunity.

Well, I did miss out on the iPod, but I guarantee you I am paying attention now to the emergence of electric cars. I saw a report a few months ago that Canada's Zenn electric car company has partnered with some American guy who has come up with a post-battery electric storage system that can recharge in under 10 minutes. I saw another report about a Japanese guy who has invented a way to power an electric car with water as the fuel.

We are living in revolutionary times. Old things are dying and new things are being born. "The Oil Companies" are not going to kill you or suppress your technology, but they will buy any good idea that will preserve their cashflow in an economy where oil is only one of a number of viable energy options. Just as Detroit is the only player positioned to remake the auto industry, so Big Oil is the only player positioned to remake the energy industry.

So in the medium term buy big oil. Right now they have the only game in town. For gamblers buy alt-tech car and energy companies. One of them will become Microsoft. More will be bought out. Some will be losers. But it's going to be one helluva ride!

2008 Nov 13 08:13 PM