Saturday, 17 November 2012

...tariffs are 0% on vehicles shipped from Mexico...
Honda is building a full-sized assembly plant (200K units per year) as is Mazda; Nissan is adding a 3rd plant. Part of that is driven by the strength of the yen, at ¥81.3 per US$ on 17 November; the US is the biggest source of profits for the auto industry, so sourcing vehicles for the US market from a non-yen location is important. [The Euro is also strong, to which anyone who has traveled there on a dollar budget can attest. So while VW has operations in Mexico, here I focus on the Japan angle, because I'm teaching a course on the Japanese economy.]
But why Mexico? Logistics costs are high, because most vehicles will likely be exported and because the local supplier base is not as deep as in the US midwest (hence parts must be imported). So while quality is high and wages are competitive, it's not a priori a natural choice.
The answer lies in free trade agreements: Mexico has been more aggressive on that front than the US (and Japan). As a result not only can vehicles be shipped tariff-free to the US–0% from Mexico versus 2.5% on cars and 25% on trucks shipped from Japan. Ditto Europe–tariffs are 0% from Mexico versus 10% on vehicles shipped from the US or Japan. (I have not researched whether Mexico has similar aggreements in Latin America.)
Now Japan could offset some of this were it to negotiate more free trade agreements. (It has one with Mexico.) But that's an awkward process, and has yet to join the biggest pending agreement (TPP, Trans Pacific Partnership). The reason: farmers, whose political clout is disproportionate to their share of the economy, and whose clout over time has led to subsidies and tariffs that allow rice farmers to remain in business despite costs that are multiples of those in other large producers. So removing protection for rice would drive most farmers out of business. In Japan, it's the "3rd rail" of electoral politics.
While we didn't hear anything about the economies of Canada and Mexico, our two biggest strategic partners, in the recent (and unlamented) US political cycle, this movement clearly benefits NAFTA and thus the US. Do higher wages in Mexico harm us? No! And while we might rather have the jobs in the US, we do pick up additional parts business. If we're going to import vehicles – and economies of scale mean that many will still be built in but a single plant globally – then better Mexico or Canada than Japan or Europe!
...mike smitka...

Tuesday, 13 November 2012

Will GM Again Go Bankrupt?

...there's not a shred of data to support BK Round II...
I've received an email making the rounds claiming General Motors is destined for bankruptcy before the end of Obama II. I've now heard the same pronouncement from several other directions. However, just because someone thinks that government support during GM's bankruptcy process was wrong does not mean it hasn't worked. I won't address any specific claim, in part because none that I have encountered looked at GM's sales data, much less perused their financial reports. It is though appropriate to ask what leads a firm towards bankruptcy, and whether there's evidence GM is heading that way.
Bankruptcy 101:Firms go bankrupt because they run out of cash.
Companies lose money all the time; they may even, temporarily or otherwise, be in a position where they're unable to pay off their creditors. But as long as they can continue to meet payroll and reimburse suppliers and contractors, they can stay in business. For a company to go bankrupt, it must run out of cash. That could be due to chance events that catch firms short, as when the sudden collapse of Lehman undermined liquidity across the financial system. It can happen because a firm, while profitable, expands too fast and has bills come due that it can't pay because its customers have yet to pay. Most often, of course, it's a result of cumulative losses that impair a firm's ability to borrow, and eventually the losses drain it of cash. Once it runs out, it has no option but to file for Chapter 11. It then needs put together a restructuring plan and to find lenders to provide cash in the interim. Failing that, a firm faces dissolution, Chapter 7, when it simply (well, for a large firm not so simply) shuts downs and a trustee then liquidates anything that might have value.
In GM's case it had a core business that appeared sustainable: new car and truck models in the pipeline, factories that were actually high in productivity. It also had fundamentally unprofitable operations, and owed too many people too much money. To survive it thus needed to shut down parts of its operations, and unload debt. But to restart the new company needed cash to pay workers and suppliers. As it happened, the 2008-9 financial crisis meant neither existing bondholders nor investment banks were willing to fight for a piece of the new GM; risk finance wasn't available on any terms. Only the government proved willing and able to provide the substantial working capital – "DIP" financing – GM required. That was what made GM's bankruptcy process unusual: with only one party involved, negotiating a speedy exit from bankruptcy took weeks, not years.
So that leads to one fundamental question: will GM run out of cash in the near term? The answer comes in two parts:
  1. is GM cashflow positive?
  2. does GM have access to (undrawn) credit lines?
Of course GM may face longer term issues that undermine cashflow and render its credit lines inadequate. The natural followup questions are thus:
  1. is GM profitable?
  2. are they doing well in their two largest markets, that is, does their core business seem to be faring well?
  3. are their non-core businesses doing so poorly elsewhere as to threaten corporate viability?
  4. are there other red flags?
First the main points:
  1. is GM cashflow positive?
    Companies go bankrupt not because they lose money but because they run out of cash. That was what happened in Spring 2009 (and was also why GM needed new money – additional loans – to keep operating). GM is no longer running through cash, it is adding to cash. In 2012Q3 it had +$3.1 billion in net cash flow and +$1.2 billion in automotive free cash flow (up from 2011Q3 levels of +$1.8 bil and +$0.3 bil, respectively).
    So there's no evidence that GM has problems. Overall it has $37.5 billion in automotive liquidity, versus global revenue of $37.6 billion. Their balance sheet is healthy – that after all is a basic outcome of a successful bankruptcy.
  2. does GM have access to (undrawn) credit lines?
    GM just negotiated $11 billion of additional credit lines, replacing roughly $5 billion in existing lines. They have access to twice as much liquidity in the event of another recession, and at a lower interest rate (e.g., no longer at "junk bond" rates). Remember, access to liquidity was the key differentiator between Ford and GM in 2009: Ford was pro-active, drawing down all their credit lines and mortgaging everything they owned, down to the Blue Oval, while selling of Volvo, Jaguar, Mazda and anything else that wasn't a core asset, even if it meant receiving bargain-basement prices. GM had fewer such assets, and waited too long and so couldn't draw down their credit lines. GM is determined not to get caught short again.
    Meanwhile, because it did not go through bankruptcy, Ford is still loaded with debt. Its balance sheet is much less healthy than that of GM.
Now to the subsidiary points:
  1. is GM profitable?
    Yes. On an EBIT (earnings before interest and tax) basis GM earned $2.3 billion, up from $2.2 billion in 2011Q3 – despite the ongoing bloodbath among the mass-market producers in Europe. GM earned money in Asia, in Latin America, in North America and on their (presently small) finance operations. Profits were down to $1.8 billion in North America (from $2.2 billion) but remain healthy.
  2. are they doing well in their two largest markets?
    Here the answer is easy: sales are up for all US brands, cars and trucks. GM is no longer a non-player in any segment. In the US market share is stable while fleet sales are down to sensible levels and used car residual values are up. Sales in China are increasing at double-digit rates in a stagnant market. They continue to invest in new capacity and new models, and (given profitability) are able to use China as a vehicle [pun intended] to launch new technologies.
    By the predicted date of bankruptcy (2016) GM will have launched 23 new models and 13 new powertrains. They will remain at the top end in fuel efficiency, something that consumers are slowly starting to realize. Of course, everyone else is launching a plethora of new models. But unlike Chrysler, new model development never came to a standstill.
  3. are they faring so poorly elsewhere as to threaten corporate viability?
    Europe is bad; Opel has lost money for most of the past two decades. Of course overall sales are down roughly 20%, so at the moment everyone else is losing money there, too (except possibly VW); autos remain a high fixed-cost industry. Ford has already shuttered plants; so have various suppliers. At some point GM will decide whether they should remain in the market or exit; so far they have only slated the Bochum plant for closure, though they have cut shifts elsewhere.
  4. what other red flags are there?
    Despite its bankruptcy, GM remains liable for white-collar pensions. (Thank goodness! – that would have left taxpayers with liabilities through the Pension Benefit Guarantee Corporation, yet hurt pensioneers because of the modest cap on PBGC payments. Of course we bear an indirect cost because GM's share price remains lower…) They continue to address legacy costs, in contrast to their lackadaisical approach in the pre-bankruptcy era. In particular, they just consummated a neat deal with Prudential to offer lump-sum payments to (white collar) retirees and thereby remove the drain on cash to pay pensions by turning it into a one-time payment. It's not a full solution, but it does cover 30% of white-collar retirees.
    It also continues to provide healthcare coverage to current employees (but not pre-2009 white-collar retirees). However this does not distinguish GM from any other automotive firm producing in the United States.
    One millstone around GM's neck in 2008 was its financial arm, GMAC, which had gone hand over fist into real estate lending. GMAC however is gone, with those operations moving into what is now Ally Bank. Whether Ally can implement a profitable business model or will remain a dud bank remains to be seen; if it fails, however, that will no longer affect GM. Meanwhile, banks and other financial institutions have re-entered the auto finance business, so that dealers can get "floor plan" (loans to cover their inventory) and car buyers can get loans. GM will over time rebuild an in-house financial arm, to provide a more reliable source of such financing -- GM has a strong incentive to keep lending to dealers, while banks have a history of leaving when times are tough. Of course, that means GM can charge a premium on its loans. But as long as it sticks close to its knitting – no more chasing after real estate or other financial fads – such lending operations will not threaten the rest of GM. In any case, it will take many years for these operations to grow in scale. A decade hence, when current management has retired, we could see a larger GM finance arm get caught up in a bubble. Between its smaller scale and a management determined not to get burned again, there is no risk on that front over the next 5-6 years.
    Finally, I do not know what sort of liabilities might remain if GM closes large portions of Opel. However, because the rest of the world provides healthcare coverage, legacy costs will so large as to threaten the company, in contrast to 2009, when as a group retirees were GM's biggest creditor.
To summarize, there's not a shred of evidence to support BK Round II. GM has a healthy balance sheet and positive cash flow, and strong positives in all markets outside Europe. Potential threats are too small in magnitude to undermine the overall firm. There is absolutely nothing to suggest GM is in danger, now or in the next 3-4 years.
That however does not mean that you should buy GM's stock, as opposed to its cars and tracks! I have no particular insight into whether GM's share price is high or low; an economist doesn't receive a crystal ball when they receive their PhD. Arguing that case requires doing an analysis of whether today's price adequately reflects likely profits over the next several years (if you take a "fundamental" approach) or arguing that market fads will lead to higher demand for its shares (a "psychological" approach, technical or otherwise). I'm not trained in that, and try not to opine one way or the other.
As for me, the 2013 Chevy Malibu remains on my short-list to replace a 1998 Volvo for which my mechanic has issued a "DNR" the moment I'm leaning towards the Ford C-Max hybrid, but my wife has the deciding vote.
...mike smitka...
Acknowledgments: in May 2010 my students (and I!) were treated to a lecture on this issue at Ford's headquarters by CFO Lewis Booth, who he spent 2 hours explaining how Ford itself (barely) avoided bankruptcy. "No cash = Bankruptcy" was central to how he organized that story, which I hope he will write up at some point.
Addendum: Some of this brouhaha apparently stems from a Louis Woodhill Forbes article
"General Motors Is Headed For Bankruptcy -- Again" that focuses on the evaluation of a single model, the Malibu, in Car and Driver. That article does not provide sales data on the Malibu, nor the impression of other car magazines. Having test-driven competitive models over the past couple weeks, the Malibu is by far the quietest and smoothest. Forbes (or rather Car and Driver) criticizes its rear legroom and failure to lead in mpg. If mgp were what sold cars, fine, but canvassing car lots clearly shows that's not dominant in American minds. Others have the headline (such as The Week) but in fact merely describe GM as having challenges, far short of the "bankrupt again" headline.