Fitch: Successful UAW Negotiations Vital for Ford upon Restructuring
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Despite incurring long-term market share losses, price competition and recent product mix deterioration, Ford did relatively well in maintaining revenues during 2005. Progress in certain segments (namely passenger cars) and the key F-Series provided important volume support during 2005. Volumes were also aided by significant incentive programs, particularly the family discount program. However, price competition throughout the industry is expected to remain fierce, Ford will face increasing product competition in the large pickup segment through 2007 from domestic and transplant manufacturers, and the trough for profitable SUV volumes remains uncertain. Restoration of margins in the near term will have to be achieved largely through cost reductions, a difficult task in light of increasing commodity and heath care costs, and significant stresses throughout its North American supplier base.
Market share and revenue performance will require continuous successful product development over the intermediate term, especially in light of Ford's restructuring program which is expected to include the phasing out of several product lines. In addition, improvement in the product lineup will have to occur in segments where Ford is not currently competitive. Given the extent of category and capacity expansion planned by transplant competition, in addition to the large margin advantage enjoyed by the transplants, Ford's success in new product segments is far from assured.
Ford's ability to prevent further cash flow erosion will be dependent on its success in negotiations with the UAW to address the most entrenched and inflexible portions of its cost structure. Ford has made steady progress in productivity and cost reduction efforts over the past several years, downsizing its cost structure in line with its market share losses and thereby avoiding more serious cash drains and balance sheet deterioration. However, further cost reductions will now require more aggressive actions to its fixed cost structure in the areas of capacity reductions, facility closures and employee headcount reductions. The pace and extent of the restructuring will be governed in large part through negotiations with the UAW, with results likely to occur only over an extended, multi-year time frame. Incorporating restructuring-related outflows (from the new plan and from the continuing restructuring of the Visteon assets), Ford is unlikely to produce free cash flow in 2006 despite a relatively favorable economic environment. Any deterioration in economic conditions could accelerate negative cash flows and begin to erode Ford's current substantial liquidity.
Ford's resulting fixed cost structure, the level of legacy costs, and any incremental flexibility granted to Ford by the UAW remains uncertain. The very narrow UAW ratification of Ford's recent health care agreement with the UAW could signal that Ford may not be able to execute the plan within the timeline the company has forecast.
Given the proximity of the UAW discussions to the 2007 contract negotiations, current talks with Ford and GM are likely to be, in effect, the opening round of the 2007 contract talks. The recent health care agreements with Ford and GM, as well as events at Visteon and Delphi, have placed a wide range of topics into current discussions. In addition to facility closures and headcount reductions, items such as jobs banks, work rules, and wage and benefit levels are expected to be at the core of restructuring discussions.
In addition to further reductions in health care benefits, Fitch expects that Ford and GM will attempt to explore alternatives to the current structure of defined benefit plans. Through these efforts, the OEM's would seek to lower benefits accruing to existing workers, transition to some form of a defined contribution program, and reduce its exposure to pension asset returns. With the financial stress that the industry is facing, the risks of higher required contributions associated with pending pension legislation, and the continuing trend away from defined benefit plans, the environment could be conducive to negotiating changes to the traditional defined benefit structure. The substantial asset levels in Ford and GM's U.S. pension plans provide flexibility in meeting existing obligations while reducing longer-term accruals.
Ford's substantial liquidity, recently supplemented by proceeds from the sale of Hertz, provide a healthy level of financial resources that will aid the company's efforts to effectively buy its way out of its existing cost structure. Ford could also benefit from any progress General Motors is able to make in its negotiations with UAW. However, the younger work force at Ford will make comparable attrition programs more expensive. Accelerated retirements will also increase pension and OPEB-related outflows.
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