New Auto Discounts A Double Edged Sword

December 5, 2002; John Lippert writing for Bloomberg reported that U.S. automakers, using discounts, are on pace to post their second-best sales year ever in North America. What they aren't making more of is profits.

The 16 largest automakers by sales in North America, led by General Motors Corp., Ford Motor Co. and DaimlerChrysler AG's Chrysler unit, increased spending on rebates and other incentives to a record $3,746 per car in September, CNW Marketing Research said. Automakers will sell 19.8 million cars and light trucks in North America this year, research firm Global Insight Inc. said. That would almost equal the record of 19.9 million set in 2000.

At the same time, profits before interest and taxes at General Motors, Ford and Chrysler will fall to a combined $8.37 billion this year, Merrill Lynch & Co. analyst John Casesa estimates. While that figure would represent a 34-fold increase from last year's $242 million, it would still be 51 percent below the $17.15 billion in profits they recorded in 2000, the last year before automakers began relying on interest-free loans.

"These companies cannot stay independent unless they reverse this decline," Casesa said of General Motors and Ford, which he rates "neutral."

Brian Bruce, who holds General Motors and Ford shares among the $13 billion he helps manage as director of global investments at PanAgora Asset Management Investors, said North American automakers must kick the discounting habit.

"General Motors is basically giving away profits," said Bruce. "Ford is following suit. I'm real concerned about profitability going forward."

North American focus

The stocks of the U.S.-based automakers have declined as the companies have turned to incentives. Ford's shares have fallen 35 percent this year, closing at $10.15 Dec. 4, General Motors's shares have dropped 21 percent to $38.41 and DaimlerChrysler's U.S. stock has declined 17 percent to $34.74.

Japanese and European automakers, led by Toyota Motor Corp., Honda Motor Co. and Bayerische Motoren Werke AG, are expanding capacity in North America to make up for reduced demand at home. Toyota, Honda and Nissan will earn a combined $20.8 billion this year, 62 percent more than in 2000, Casesa said.

General Motors, Ford and Chrysler are fighting back with discounts. As their prices fall, though, their pension and labor costs continue to rise -- creating a profit squeeze.

The expenses mean that Ford now makes about $1,300 on each 2003 model F-150 pickup truck it sells for $23,000, less than the $2,300 it collected on 2002 models, Casesa said.

General Motors, the world's largest automaker, kicked off the discounting in 2001 by offering interest-free loans to lure buyers back into showrooms after the Sept. 11 terrorist attacks. The rebates have been a fixture of the industry ever since.

Incentive spending

Per-vehicle incentives rose 13 percent in October from the year-earlier month to $3,816 at Ford, 13 percent to $3,729 at General Motors and 9.3 percent to $3,547 at Chrysler, according to CNW Marketing Research.

Toyota also boosted incentives in October, by 17 percent from the year-earlier month, said CNW President Art Spinella. That brings the Japanese automaker's North American discounts to a per-vehicle average of $2,318.

Toyota spends less on incentives than most rivals because customers regard its cars as more reliable, said James Schroer, Chrysler's executive vice president for marketing. A $20,000 car built by Toyota retains 55 percent of its value after three years, more than the 40 percent for models made by General Motors, Ford and Chrysler, he said.

U.S. auto sales for November indicate that the benefits of incentives are waning. General Motors, Ford, Chrysler and Toyota had lower sales last month as discounting drew fewer buyers than in the year-earlier November, when sales reached a record. Sales last month slid 18 percent at General Motors, 20 percent at Ford, 12 percent at Chrysler and 5.2 percent at Toyota.

Lower demand

The lower demand means that General Motors and Ford are making too many light trucks, which may lead to more discounts, Goldman, Sachs & Co. analyst Gary Lapidus said in a report.

"That likely means a collapse in light truck profits during 2003," he wrote.

Toyota holds another advantage over its rivals: Its manufacturing costs are as much as $1,500 per vehicle lower than those at General Motors, Ford and Chrysler, Lapidus said. That helped Toyota have net income of 554 billion yen in the six months ended Sept. 30, a 90 percent increase from the year-earlier period.

Toyota's results included 186 billion yen from transferring part of the automaker's pension obligations to the government. Japan's Ministry of Health, Labor and Welfare is taking responsibility for some employee pension funds after pressure from business leaders trying to cover pension shortfalls.

Competition from Japan

Toyota's stock has fallen 6.3 percent this year, closing at 3270 yen on Dec. 4. Its American depositary receipts have risen 3.8 percent this year to $52.90.

The U.S.-based automakers also have competition from Nissan, which is building a factory in Canton, Mississippi, to produce 400,000 minivans, pickups, sport-utilities and Altima midsize sedans a year starting in 2004. Nissan plans to roll out 28 new models in the next three years.

France's Renault SA bought a 37-percent stake in Nissan in May 1999 and later made Renault executive Carlos Ghosn the Japanese automaker's chief executive officer. Renault raised its stake to 44.4 percent this year. Nissan plans to reduce purchasing costs 15 percent in the next three years as it increases sales by 1 million vehicles, or about 40 percent more than for the fiscal year that ends March 31, 2002. Nissan's stock has climbed 31 percent this year to close at 949 yen on Dec. 4.

Reducing costs

General Motors, Ford and Chrysler, the three biggest automakers by sales in North America, need to reduce costs and shut factories, said Thomas Stallkamp, a former Chrysler president who is now chief executive of the engineering firm MSX International Inc., based in Southfield, Mich.

"We have only a limited time before the nature of the business is irreparably harmed," Stallkamp said.

Automakers worldwide have a glut of manufacturing capacity. They operate factories capable of building 90 million vehicles a year, said Morgan Stanley analyst Stephen Girsky. This year, they will sell only 56.15 million vehicles, up 0.06 percent from 2001, according to Global Insight.

General Motors, Ford and Chrysler are on pace to lose more market share at home. Their combined share will fall to 61.5 percent this year, down from 72.9 percent in 1996, with most of the slack taken up by Toyota, Honda and Nissan, according to market research company Autodata Corp. The 61.5 percent market share for U.S. automakers this year includes November's record low of 58.8 percent.

'Complacency'

"The Detroit automakers got lulled into a state of complacency in the early 1990s, and they did not maintain their product innovation," said Gary Motyl, who oversees $25 billion as chief investment officer of Templeton Institutional Global Equities. Motyl has reduced auto stocks to 1 percent of his portfolio from 3 percent four years ago.

Ford, for example, is still building essentially the same mid-sized Taurus sedan that was the best-selling car in the United States in 1996, only now the Taurus ranks third behind two completely redesigned models -- the Toyota Camry and Honda Accord. General Motors didn't announce the end of the Oldsmobile line until sales for the brand fell to 289,172 in 2000, from more than 1 million in 1986.

Pension liabilities may rise at General Motors to about $23 billion at year end from $9.0 billion the same time in 2001. The company has offered employees early retirement programs to reduce its workforce, and a 20-percent decline in the Standard & Poor's 500 Index this year has reduced investment income on pension assets.

Pension costs

General Motors spends $842 on pensions for every vehicle it builds in North America, more than the $321 spent by Ford and the $100 at Toyota, according to Morgan Stanley's Girsky. Toyota opened its first North American plant in 1984, giving the company a younger workforce, and lower pension costs.

The third-quarter loss at General Motors widened to $804 million from $368 million in the year-earlier quarter, partly because General Motors wrote down the value of its investment in Fiat SpA by $1.37 billion to $220 million. Its pension costs won't fall significantly until 2014, when the current generation of retirees starts to decline, said Chairman John F. Smith Jr. in an interview.

Reliance on discounting

For now, General Motors has no plans to reduce incentives, said Smith.

The automaker is trying to improve profits by building more efficient plants, said Gary Cowger, the company's group vice president for manufacturing. General Motors introduced its redesigned 2003 Silverado pickup truck after taking a weekend to reconfigure its factories, he said. A decade ago, the automaker would have needed as long as six weeks for a similar changeover, Cowger said.

Ford, the world's second-largest automaker, is using incentives to respond to larger rival General Motors. "We can't unilaterally put the brakes on incentives," Ford Chief Executive Officer Bill Ford said in a conference call with investors in October.

Ford lost $5.45 billion last year, prompting the company to embark on a five-year plan to eliminate 23,000 jobs, close five plants and stop building slower selling and less profitable models such as the Escort small car and Lincoln Continental luxury sedan.

Chrysler

Chrysler is also reorganizing. Parent DaimlerChrysler has eliminated 26,000 jobs and shut plants in Canada and Mexico in an attempt to boost profitability at the U.S. unit.

Chrysler's factory productivity will increase as much as 10 percent in 2002, three times faster than in past years, because the automaker is designing parts for use in more models, Chief Operating Officer Wolfgang Bernhard said in an interview. Chrysler is saving $7 million a year by halving the number of its headlight styles to nine from 18, said Chief Information Officer Sue Unger.

Such moves helped Chrysler earn 325 million euros ($328.6 million) in the third quarter, compared to a loss of 267 million euros in the year-earlier quarter. "We're not in intensive care anymore," Bernhard said.

The three U.S.-based automakers may have a 90-day supply of unsold cars and trucks sitting on dealer lots by Christmas, more than the typical 73-day supply, Girsky said. General Motors, Ford and Chrysler may need to reduce first-quarter production, he said, a move some investors would welcome.

'Huge overcapacity'

"They all face huge issues of retirement costs and unions that won't let them close factories even in the face of huge overcapacity," said Steven Kus, an RBC Dain Rauscher Corp. vice president who manages $250 million, including shares of General Motors, Ford and DaimlerChrysler.

Faced with those challenges, the three automakers need to lessen their reliance on discounts to increase profits, he said.

"One of the main things we look for in a stock is strong and stable pricing," said Kus. "The Detroit automakers don't have anything like that."