Auto & Auto Parts

The industry is very concentrated, with the top 8 global auto companies having more than 90% of global revenues and the top 50 global auto parts companies having 80% of global revenues (the top 4 US tire producers have 75% of the US market).

There is a focus on automation and simplifying product lines to lower costs and benefit from economies of scale. The average car now needs only 15-25 man-hours per vehicle and this drops 2% annually.

Hybrid/alternative cars represent a source of growth in the future. Market share gains by hybrids/alternatives will be slow, and they are now only 4% of cars on the road.

Back in December of 2008, President Bush approved an emergency bailout of the U.S. auto industry, offering $17.4 billion in rescue loans in exchange for tough concessions from the deeply troubled carmakers and their workers. The government will have the option of becoming a stockholder in the companies, in effect partially nationalizing the industry.

If the carmakers fail to prove viability by March 31, 2009, they will be required to repay the loans, which they would find all but impossible. A firm will be deemed viable only if it can show positive cash flow and can fully repay the government loans. Under terms of the loan, General Motors ( GM - Analyst Report ) and Chrysler must provide the government with stock warrants giving it the option to buy GM and Chrysler stock at a specific price. In addition, the automakers would be required to agree to limits on executive pay and eliminate some perks such as corporate jets.

This is a band-aid, but not the surgery this industry needs. In essence, we see this as the first step towards a long-term solution, which will include the following:

• Getting a bankruptcy attorney and filing ASAP -- this measure extends this until March 31. Then healthcare and pension issues can be removed and this would go a long way towards making Detroit competitive with foreign manufacturers
• Separate dealerships from the rest of the company. The parts and service issue can be guaranteed by the US Government and these companies can be separated and recapitalized from the rest of the Big Three. We find it hard to believe that consumers would buy something from a bankrupt company
• Get a labor attorney and have a nasty confrontation with the UAW while in bankruptcy. This would be the worst labor showdown in out memory and may involve the Supreme Court at some point
• Have the US Government be a DIP [debtor-in-possession] financer, as opposed to writing blank checks to the auto manufacturers. They are there to support -- but not nationalize -- the industry. The challenge will be when to get these companies out of the private sector hospital, which is the US Government
• Focus on only 35+ MPG vehicles. Transition from SUV to AFV (Alternative-Fuel Vehicles)
• Remove the top 50 officers of the all of the Big Three and replace them with outsiders. Encourage creative and dynamic thinking
• The US Government should look at tariffs and quotas to protect these companies as they restructure. Also, this would force foreign manufacturers to build plants in the US rather than export, which would make a worker-retraining issue a worker-relocation issue, which is far easier to deal with
• Consumers should be allowed to deduct automotive interest, which would increase demand for autos and alleviate the credit issue that surrounds the industry now. Perhaps this can be for AFVs and 35+ MPG vehicles only. There should be a punitive tax on SUVs which will make them unaffordable for consumers. These tax revenues can fund growth of the AFVs and high MPG vehicles with tax credits
• Global alliances should be forged among the manufacturers to take advantage of global economies of scale. These new "super-car" companies would be able to tap into the Chinese and Indian markets, where the car industry is a growth business and billions of people are screaming for a new car, not just a second hand retread from the US or Europe. Economies of scale/Rationalization and China/India increasing the global baseline demand for cars may permanently increase profitability for the industry and avoid this situation from happening again

Earnings are below expectations and have been for some time. Some of these companies may be bailout candidates, which would leave equity holders with no value. Demand for autos is down (15)% due to a weak economy and weakening real estate market.

Demand is also hurt by weakening employment. The recent credit crunch is crippling to auto sales, and this has a trickle-down effect throughout the industry.

Furthermore, there is a slowdown of SUV sales, which are 55% of sales (cars are 45%). Imports have also been more competitive, as they tend to have better gas mileage. Costs for domestic producers is much higher than seen for foreign producers, and this is creating a loss of market share in the US by US producers.

The presence of unions has led to costs being much higher than seen in other countries. Pricing averages (2)% in this sector annually. Incentives are increasing as the industry is trying to increase sales. Overcapacity is about 20% in this sector. Pension deficits are rising due to a weak stock market, lower interest rates and less pension funding.

Auto sales were very weak in February, but this is a continuation of an ongoing trend. Overall sales are down 41% and were the worst since 1981. The average incentive was $2900, which is up 8% and was unable to stimulate sales. Ford ( F - Analyst Report ) sales were off 50%, mainly due to a tired product line and weak F-series sales. GM ( GM - Analyst Report ) sales were down 53%, with weakness in the SUV part of the product line. Chrysler sales were down 44%, even with average incentives of $5,500, which is 20% of the price of a car.

Honda ( HMC - Analyst Report ) sales were off 38%, which is 3% higher that the market and shows why they are the best of the "Big-4" automakers (Honda sources more of its content from the USA than even Chrysler). Nissan ( NSANY ) sales were down 37%. Toyota ( TM - Analyst Report ) sales were off 40%. We suspect sales were weak in the SUV part of the product line. Hyundai continued to buck the trend and had flat sales, which implies that their "return your car if you lose your job" program is having huge success.

BUY/SELL RATINGS

Autoliv (ALV) is a Sell due to the slowdown in the auto market and weak pricing. AutoNation (AN) is a Sell due the slowdown in the auto market and exposure to California. American Axle and Manufacturing (AXL) is a sell due to the slowdown in the auto market and costs related to the new UAW agreement.

Ford and General Motors are Sells and bailout candidates that need major restructuring. CarMax (KMX) is a Sell due the weak auto market and falling prices. Lear (LEA) is a bankruptcy candidate. TRW Automotive (TRW) is a Sell due to the weak auto market.