As US Automakers came out of recession, Ford (NYSE:F) and GM (NYSE:GM) have steadily grown their top line, worked double time to increase profitability in key markets outside the United States, and slowly moved our sentiments about the companies into a positive one. I have written about this extensively in my previous articles, the latest of which was published early Thursday morning: "U.S. Automakers Update: Market Successfully Corrects Its Worst-Case Scenario"
In that article, I also praised both Ford and GM for the things they've done. But everything only seems to be going well as long as you keep your eyes away from their financial statements.
For the past few years, sales have been as good as it gets, figuratively speaking. With average automobile sales in the United States hovering around the 16-17 million mark, both companies have fallen back to their complacent mode; essentially, both have failed to learn the lessons of the recession. Their respective sales and top lines have once again become high-priority items, while fiscal prudence ranks very close to the bottom of the list.
2015 Vehicle Sales of Global Automakers
In terms of operations, Toyota, GM and Ford are all global companies, but Toyota leads the pack with 10+ million vehicles, while GM sells 9+ million and Ford does 6+ million each year.
Now, let's jump from that into the net profit that each of the three companies makes every quarter.
If you notice a disparity, that's because there is one - and a huge one at that.
Just because you're big doesn't mean that you have to earn less
So the world's largest automaker seems to have the largest operating margins as well. Except for 2009, when the wrath of the recession was felt, Toyota remained profitable. We all know what happened with Ford and General Motors, but that is not the problem itself.
The key point here is that once economic activity returned, Toyota's operating margin returned to near 10%, while that of both Ford and GM continues to languish.
It's an interesting position for the U.S. automakers to be in, because now they cannot cite their size as an excuse for not having high margins, or can they blame it on the market or the industry or anything else, because Toyota and Volkswagen (OTCPK:VLKAY) play to the exact same rules in every country - including the United States.
Recessionary environments don't care if a company is Japanese or American; every company goes through the same things, essentially - jobs are lost, confidence tanks and money has to be watched carefully. But the real test of a well-run organization is how quickly it can get back to normalcy after the hardest period of the recession passes.
So, how was Toyota able to bounce back so fast when GM and Ford took several years to shake off the effects of the recession? More importantly, what is this factor that is creating a widening gulf between the top company and the rest of the field?
That answer can only come from Toyota's global footprint. But it's not what you think. Of course, GM and Ford have a comparable presence around the world, but it's the profitability of those segments that sets Toyota apart from the U.S. carmakers.
That's why a major recession in one or a few markets doesn't hit them as hard as it would GM or Ford. They have a measure of insulation from a recessionary environment because they aren't dependent on one single market for their profitability - not even one as large and mature as the United States.
Though I don't see economic headwinds soon, you can bet your bottom dollar it'll come - and when that happens, I just don't think GM and Ford are ready to handle it the way Toyota can. The sooner they prepare themselves for tough times that may lie ahead, the better it will be for both companies.
Be a King at Home, but Not a Slouch Overseas
Toyota is not so different from GM and Ford, because the company retains the crown in its home country Japan, which accounts for nearly 58% of its operating income. The significant aspect of that figure is the 42% that comes from other markets: 18% from North America and 20% from the rest of Asia and other continents.
For GM and Ford, however, their home market is everything; every other unit is either making losses or just barely profitable. This is the biggest problem both these companies face - and also one of the reasons why Toyota enjoys a much higher valuation compared to the rest.
Toyota's price to sale valuation is over 0.6, while GM and Ford sit at exactly half of that.
Investor-speak: Single-market Dependency
This is the biggest problem with a lot of U.S. companies recently. Even something as positive as a strengthening dollar creates headwinds for their overseas earnings. Of course, they can't change their home country just to avoid foreign currency fluctuations because it could work either way. What I'm saying is that they need to take their overseas profitability as seriously as they do their top and bottom lines at home.
Toyota stands out not because it is a Japanese company, but because its global strategy does not focus on a single market or region. You can see this clearly from the graph below even if you aren't familiar with that part of their business.
Europe is their only weak point; other than that, they have spread their risk base across Asia, North America, Japan and other markets. They've also managed to be profitable in all these markets, unlike Ford and GM.
Until the U.S. carmakers double down on other markets and get them to the kind of profitability levels that the U.S. divisions can boast of, they run the risk of incurring significant losses every time the U.S. economy dips.
In my opinion, this is the best time to do it. While both companies are relatively stable and have a good run ahead of them, they need to figure out how to be as profitable overseas as they are in the United States. And that's only the first step: the more important long-term "moat" they need to build around their businesses is higher profit margins.
It the only way for them to grow from strength to strength, and I see it as the only way forward if they want to be anywhere near Toyota, and stand up and be globally recognized as companies with respectable valuations and recession-resilient operational models.
The increased dependency in one single market is the single biggest reason why their stocks remain volatile. The moment the market thinks or expects even a mild shock to the US economy, investors start to flee both the companies, partly because of the aftertaste of prior recession and partly because sales will have to drop. But it's understandable and there is no way out as of now. Till GM and Ford start posting consistent profits outside and grow their earnings outside the United States, the fortune of their stock is directly tied to just one single economy, the United States.
Things are good now. They have already had a string of successful years and if they don't change the current status quo outside the United States within the next four to five years, it will be an extremely hard ride for investors who have given these companies their hard-earned money.
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