Detroit’s Bumpiest Road Is Wall St., Unjustifiably So
Despite the fact that Ford Motor Co. reported record profits last week, and that General Motors Corp. announced surprisingly healthy profits as well, the stock market remained notably unimpressed.
Shares of both Ford and GM ended the week fractionally lower. And that investor indifference is typical. Even as most stocks have soared to unprecedented heights, shares of automobile companies have continued to trade at seven to eight times earnings per share.
As often happens, the mass of investors are being shortsighted, although their bearishness is understandable.
Truth is, the outlook is decidedly clouded for the 20th century’s most important industry--employer of 10 million workers and generator of $1 trillion in sales--as it moves into the 21st.
A major problem is that the world has too many car producers. Global capacity exists now to produce 18 million more vehicles than customers are buying--a 26% surplus that will grow more severe in the next few years.
New car makers are coming on the scene. Samsung Electronics of South Korea will start shipping its new car, an adaptation of Japan’s Nissan Maxima, into the U.S. market next year; a car from Daewoo of South Korea also arrives next year.
The developing countries of Asia and Latin America are new consumer markets for automobiles, but not only that. They want to produce cars too. “It makes sense for them,” says Doug Kevorkian, a Detroit-based auto consultant who advises South Korean firms. “Car manufacturing trains skilled labor and gives developing countries a high-value product to export.”
The car business today recalls the steel industry 40 years ago, when every new country wanted a steel mill. Their surplus production devastated Pittsburgh and other steel centers and changed the industry forever.
On top of that, environmental concerns are rising. Tougher U.S. clean-air rules were signed into law last month. And an international conference on global warming this December may introduce restrictions that will boost fuel prices. That could cool down America’s love affair with sport-utility vehicles--trucks that drive with the comfort of cars but get only 14 to 18 miles per gallon of gas.
Yet there is another perspective to explain what is happening. The world’s leading car companies--Ford, GM, Toyota, Honda, Volkswagen, perhaps Chrysler, Nissan, Fiat, Mercedes and BMW too--are getting stronger as they increase the scale of their global operations.
This is reflected in the profitable performances reported last week. As Ford’s example makes clear, the leading car companies are becoming more efficient.
When Ford last week reported almost $4 billion of profit for the first six months of 1997, it said nearly half that amount came from cost reductions. That was welcome news to Wall Street, says analyst Maryann Keller of Furman Selz, a New York brokerage firm. “Investors were waiting for Ford to make progress on its cost-reduction program.”
The cuts came from concentrating suppliers and getting them to provide sub-assemblies, rather than single parts, an economy measure that aerospace companies employ.
It came also from making efficient use of designs and materials. Ford is using the tools and machinery for its old Fiesta car to make an automobile for developing countries called the Ka.
The economies did not come from cutting people. Ford employs 372,000 today, more than at any time in the last decade. In any event, direct labor now accounts for less than 12% of total costs at Ford, according to analyst Gary Lapidus of Sanford C. Bernstein, a New York-based financial research firm. Purchased materials, at more than 50%, are a much bigger cost item, which is why companies are concentrating on supplier relationships.
Some costs rose. Ford had to put more money into reserves against falling prices for cars coming back to dealers after two-year leases. But leases are a competitive tool against low-priced cars, explains a major auto dealer.
“After a two-year lease, major manufacturers can sell an ‘almost new’ brand-name car at prices competitive with new cars” from lesser-known makers. Such lease programs are hurting Hyundai of South Korea, the dealer explains.
That’s a clue that car makers will start spending heavily to build brand recognition here and abroad--to market fashionable vehicles for fickle customers.
Fashion can be very profitable. Ford is widely believed to make $11,000 on every hot new $35,000 Expedition sport-utility vehicle its dealers sell.
Environmental restrictions may cut into the craze for such gas-burners, but the long-term effect of environmental laws will be to speed development of vehicles powered by natural gas and electric fuel cells. In that sense, environmental needs will favor the major companies over smaller car firms because the majors will have the scale of operations to produce “clean” cars for a mass market.
Of course, investments will be needed, and there profit could be a problem.
For all the fanfare over sport and luxury vehicles, auto company profits overall are skimpy. Ford earns 3.7 cents on each dollar of sales; GM earns 3.5; Toyota, 3.5; Chrysler, 5--after years of stringent efficiencies. Microsoft earns 27 cents on each sales dollar. Which tells you that the auto companies have a lot more cost-cutting to do.
Yet in the larger picture, the automobile industry’s horizons are expanding. Competition is fierce but so are the prizes as giant companies contend for new customers in Asia, Eastern Europe and Latin America, as well as in the traditional U.S., Japanese and European markets.
Ford will reach $150 billion in revenue this year and invest $9 billion in expansion and renewal of its global operations. It sees particular opportunity in South America.
The stock market, in pricing car companies at only seven to eight times earnings, seems focused on the difficulties facing the business. But car companies may well be worth more than that.
In a world buying 51 million vehicles this year and more next year, it could be the wiser course to focus on the industry’s promise.
