How Are the Car Companies Really Doing?

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On Friday, President Obama was in Detroit touting the success of the government’s bailout of Chrysler and General Motors.  While many industry experts concede that there was a meaningful restructuring of these companies, the overall story is not nearly as rosy the Administration would like you to believe. 

Here are few points to keep in mind as glowing stories emerge from the president’s trip to Detroit:

Balance sheet stress. The auto companies are certainly not out of the woods yet.  There has been a massive rebuild of negative working capital balances at GM (and Ford).  What does that mean?  Well, working capital is current assets minus liabilities – and it’s a good way to measure whether a company has the liquid assets to grow or build the business (and add shareholder value).  Positive working capital is also a useful measure for gauging a company’s financial resilience.  Negative working capital, on the other hand, means that current liabilities exceed assets – and a firm in this situation can’t spend as aggressively.

For the big auto companies, topline growth is being financed (again) by borrowing from their suppliers, which increases the operating leverage and thereby the risk that another downturn could prove (very) painful on a cash flow basis.  While these balances provide a business with incremental positive cash flows in addition to operating profits in times of rising sales, they rapidly reverse themselves, draining a company of cash, when sales fall.  In short, there is still significant vulnerability in the sector in case of a macroeconomic downturn (and more so than most sectors).

Here are some rough calculations for (adjusted) working capital at Ford and GM.  These figures exclude current OPEB (other post-employment benefits) liabilities, as the decline in this figure over the last year was a result of a one-time agreement between the original equipment manufacturers and the United Auto Workers. Adjusting for this non-recurring item provides a more accurate picture of both Ford and GM’s actual working capital, and how it has become more negative over the past year.  [Note: the data for GM is only post its emergence from bankruptcy on July 2009.]

Retail auto sales remain weak.  Sales have been in the doldrums and only picked up slightly from the depths of the recession.  Early in 2010, increases in auto sales were driven, not by consumers, but by rental-car company and commercial fleet transactions.  Retail sales remain at historically low levels.  Since the early 1990s, U.S. retail customers have accounted for at least 10 million car and truck sales each year.  That wasn’t true in 2009 – and analysts like AlixPartners, project that 2010’s total sales number may fall short as well.

The “rule of law” principle that is so essential to the strength of U.S. capital markets has been undermined.  The roughshod methods that were used against bondholders in the bailout, the questionable methods used to pick winners and losers in the rush to close thousands of auto dealerships and the favorable treatment given to the unions (followed by the codification of this policy in the Orderly Liquidation Authority in the Dodd-Frank financial regulation bill) serve as the case study for why investors and lenders will be skittish about lending or investing in U.S. companies that have a big union presence and/or would be deemed Too Big To Fail by the government.

Paying back TARP  with other money from the government. The poor state of GM’s balance sheet was also highlighted earlier this year when GM ran a national ad campaign announcing that they had paid off $6 billion of their TARP loans earlier than expected.  This claim was supposed to prove that they were in good shape. Yet, the TARP Inspector General, Neil Barofsky, blew the whistle immediately: "It's good news in that they're reducing their debt, but they're doing it by taking other available TARP money."  In other words, GM used some TARP money to pay back other government loans.  Perhaps the two best statements on this topic came from Senator Carper (D-DE) and Steve Rattner, the former White House auto recovery czar.  Senator Carper said: "It sounds like it's kind of like taking money out of one pocket and putting in the other,” while Steve Rattner commented: GM “may have slightly elasticized the reality of things.”