Jeremy Kennedy, a Ford employee, secures the engine and transmission to the subframe of a new 2020 Explorer at Chicago Assembly Plant.
Not even during the Great Recession and bankruptcies of General Motors and then-Chrysler did the automotive industry come to a standstill like it has during the coronavirus pandemic.
U.S. automakers are losing billions of dollars every month with the majority of American factories shuttered since March and dealer showrooms closed or running on a limited basis.
“We’re experiencing unprecedented times as a result of this pandemic,” GM CFO Dhivya Suryadevara told investors during a call Wednesday.
No one could have prepared for Covid-19, however the Detroit automakers, including Ford Motor and Fiat Chrysler, are weathering the storm without talk of bankruptcies or the need for the same level of assistance the airline industry just received. It’s a stark contrast from 2008 and 2009.
The ‘hard way’
“The automakers themselves are in quite a bit different shape. They learned the lesson the hard way of we need to improve of balance sheet,” said Mark Wakefield, a managing director and global co-leader of the automotive and industrial practice at AlixPartners, which led GM’s bankruptcy restructuring.
Much of the optimism is a result of the Great Recession. During that time, the Detroit automakers were forced to shed billions in capital expenditures and structural costs. From then on, executives such as GM CEO and Chairman Mary Barra made it their mission to fortify balance sheets in preparation for the next downturn, despite not knowing when or how it would occur.
Those efforts resulted in tens of billions of dollars in available cash, less leverage and more flexible union contracts for vehicle production, which helps save money when plants are idled like they are now. All of which are being battle tested by Covid-19.
Morgan Stanley conducted a “shutdown analysis” earlier this year that gave it “confidence” that GM, Ford and others “can largely avoid the fate many companies experienced in 2008/2009,” leading industry analyst Adam Jonas said in an investor note.
Drawing down credit lines
To boost liquidity, the three automakers have collectively drawn down about $45 billion in credit lines to ensure they have enough cash on hand to survive the next few quarters without much, if any, production. Each of the automakers have said they have enough cash available to make it into at least the fourth-quarter without revenue if it were to come to that.
It doesn’t appear that will be necessary. Michigan’s governor announced Thursday the state’s auto manufacturers can resume operations this week. All three Detroit automakers plan to begin restarting North American vehicle production on May 18 — albeit with strict safety rules to protect employees from an outbreak. Some supporting operations are expected to reopen this week.
Depending on the length of the pandemic and impact on U.S. sales, the auto industry could potentially lobby for some sort of stimulus package to increase consumer demand. Something potentially similar to “Cash for Clunkers,” a roughly $3 billion program that offered up to $4,500 for trade-ins toward the purchase of a new vehicle.
Executives for each of the Detroit automakers backed such a program ahead of a bipartisan group of lawmakers pushing U.S. House leaders to include the American auto industry in the next round of stimulus spending.
To be sure, Wall Street and industry analysts are closely watching the automakers’ rising debt loads as well as the risk that consumers fall behind on payments as unemployment rates skyrocket to 14.7% in April. Used car pricing and off-lease fleets could also face an influx of write downs.
GM was ahead of the curve in preparing for a downturn. It exited unprofitable markets like Europe, and in November 2018 announced plans to shed thousands of jobs and close factories as part of a $6 billion cost-saving plan through 2020, which remains on track.
“All I know is we’re one day closer,” Barra said Nov. 1, 2018, weeks before the announced cuts, during The New York Times’ DealBook conference about a possible recession
GM’s efforts are now paying off. The automaker last week reported a $294 million profit for the first quarter despite the coronavirus pandemic.
The automaker also said the U.S. industry needs to sell just 10 million to 11 million vehicles in North America a year to break even, in line with its sales during the Great Recession. U.S. sales since in recent years have ranged between 15 million and 17.5 million cars and trucks a year.
RBC Capital’s Joseph Spak said GM “has come through this better than others,” while Credit Suisse’s Dan Levy said of all the automakers “argued for multiple re-rating in recent years, GM is far and away the most prominent case.”
GM’s profit in the first quarter compared to losses of $2 billion for Ford and $1.8 billion for Fiat Chrysler.
GM “entered the crisis from a position of strength and our first-quarter results demonstrate that and the discipline with which we’ve been running the business,” Suryadevara said.
Debt-to-profit ratios, which measures how leveraged the companies are, show just how much GM and Ford have fortified their balance sheets since the Great Recession. On a pretax adjusted basis, GM lost $14.74 billion in 2008, giving it a negative debt-to pretax profit ratio. Last year, it was 1.2, meaning its debt was 1.2 times its annual profit, according to Fitch Ratings.
Ford’s debt-to-profit ratio was at an eye-popping 14.1 in 2008 and just 1.4 in 2019. For the auto industry, anything under 2 is considered a healthy debt-to-profit ratio auto industry, which is requires a lot of capital.
“Both companies entered this downturn in a significantly stronger financial position, I mean a much stronger financial position, than what we saw going into the last downturn,” said Stephen Brown, a senior director at Fitch Ratings who covers GM and Ford.
Fitch Ratings estimates Ford’s cash burn for the year will be about $8.5 billion as long as North American production restarts in mid-May. GM is expected to burn through less than $3 billion in cash, according to the credit rating firm.
Combined, the Detroit automakers burned through about $8.6 billion in the first quarter, led by Fiat Chrysler at $5.5 billion and Ford at $2.2 billion. GM burned through $903 million in cash during the quarter, $600 million of which was related to the coronavirus.
Ford last month warned investors that adjusted pretax losses are estimated to top $5 billion during the second quarter, which is expected to be the worst quarter in terms of coronavirus impact for the entire auto industry.
The companies that can make it through the crisis without diluting existing shares by issuing more equity or permanently impairing their operations “may enjoy significant opportunities” down the line, according to Morgan Stanley’s Jonas. It’s one of the reasons why the firm upgraded its outlook on U.S. autos and shared mobility, including Uber and Lyft, to in-line from cautious after more than five years.
“An auto company’s top priority right now is simple: survive,” he wrote. “Do whatever it takes to get through the next one or two quarters.”
Each of the Detroit automakers have cut executive pay and announced deferred pay for salaried workers, amid other actions to preserve cash and avoid laying off salaried workers. GM and Ford also suspended their quarterly dividends, among other efforts.
GM had $33.4 billion in available liquidity to end the quarter. That includes cash, cash equivalents, marketable debt securities and funds available under credit facilities for its automotive operations. That’s slightly down from $37.2 billion to end last year, but far better the $14 billion it had in 2008.
In addition to drawing down $16 billion in credit in March, GM last month disclosed that it signed a 364-day revolving credit agreement of $1.95 billion for exclusive use by GM Financial, the company’s auto lending arm. The subsidiary had $23.9 billion in liquid assets at the end of the first quarter, which includes cash and available credit.
GM on Thursday also priced three series of senior unsecured notes for a total of $4 billion and announced plans to establish a new $2 billion credit line. The company had automotive debt of $30.3 billion to end the first quarter.
“Cash matters more than anything else. Cash is survival,” said Michael Ramsey, a vice president analyst for Gartner’s CIO research group, wrote in a blog post this month. “Profitability, earnings-per-share, revenue growth potential and other metrics that matter in a growing economy are meaningless for now.”
With so much uncertainty about the future, analysts have been somewhat reluctant to downgrade the automakers for adding debt and drawing down credit facilities. They’ve viewed it as being more important for the companies to have cash to continue paying the bills than as a negative.
An employee uses a flash grinder to smooth out the metal frame of a sports utility vehicle (SUV) on the production line at the General Motors Co. (GM) assembly plant in Arlington, Texas.
Matthew Busch | Bloomberg | Getty Images
Ford CFO Tim Stone last month said the company had $35 billion in cash as of April 24, after paying its suppliers. He said that amount is enough to get the company through the end of the year without any U.S. production if it were to come to that.
The company tapped $15.4 billion in March against two existing credit lines. Ford also sold about $8 billion in bonds, it said April 17. Ford’s debt has been downgraded to junk status and it is paying significantly higher yields on that new debt, between 8.50% and 9.625%.
GM, by comparison, remains investment grade and is paying between about 5.4% and 7% on its newest bond issuances.
Ford had $35.4 billion in liquidity for its automotive operations at the end of last year. That included its cash and total available committed automotive credit lines. That compares to $24 billion in 2008. Ford Credit, its financial arm, had $28.3 billion in liquidity at the end of the first quarter.
Fiat Chrysler said it had about $20.2 billion (18.6 billion euros) in available liquidity at the end of the first quarter. It also finalized a roughly $3.8 billion (3.5 billion euros) emergency credit facility last month. Unlike its crosstown rivals, the Italian-American automaker does not have a captive finance company, which can be a good thing in a recession when borrowers fall behind on car payments.
Auto financing concerns?
Analysts and investors are monitoring default rates, specifically in subprime lending, as well as used car prices and an expected influx of off-lease vehicles that could have to be written down. All of which helped pull the automakers to the brink of collapse during the Great Recession.
U.S. President Donald Trump, center, speaks while Jim Hackett, president and chief executive officer of Ford Motor Co., from left, Larry Kudlow, director of the U.S. National Economic Council listen during a meeting with automotive executives in the Roosevelt Room of the White House in Washington, D.C., U.S., on Friday, May 11, 2018.
Alex Edelman | Bloomberg | Getty Images
No one in the industry or at the companies foresees anything that bad on the horizon, although there are signs for some concern.
Ford Credit’s earnings declined $771 million in the first quarter of this year to $30 million due to “higher credit loss reserves, lower values of off-lease vehicles awaiting sale and anticipated lease defaults.” It’s subprime lending is less than others in the industry.
GM Financial, which earned $230 million in the first quarter, said payment deferrals (borrowers who are delaying their car payments) rose to 3.5% in April, up from a typical range of 1% to 2%.
Ally Financial, the successor to GM’s previous GMAC financial arm that was spun off prior to its bankruptcy, last month said more than 1.1 million auto customers elected to participate in its deferred payment program as of April 16. The vast majority of those people, or 76%, had never had an extension, while 70% had never been delinquent.
The rate of serious delinquencies, consumers who are 90 days or more behind on their auto loan payments, has been slowly trending upward since as early as 2012, according to the New York Federal Reserve. Auto loan delinquency rates rose slightly to 2.36% in the fourth quarter from 2.34% during the previous quarter, the NY Fed said. Auto loan balances stood at $1.33 trillion at the end of last year.
While auto lending delinquencies are a worry as unemployment rates skyrocket, Moody’s Investor Services said Wednesday the finance arms of GM and Ford are among those that have “adequate liquidity to ride out coronavirus market disruption.”
That doesn’t mean they won’t need to raise more capital by issuing more debt. The captive business model generates liquidity as assets decline, but companies still need to issue debt to support sales.
Executives with both GM and Ford touted the strength of their auto lending arms while announcing first quarter earnings.
Ford Chief Operating Officer Jim Farley said Ford Credit ” has been indispensable” during the pandemic, while GM’s Suryadevara said GM Financial is “inherently cash generative during a downturn.”
GM received a $400 million dividend from GM Financial in the first quarter, while Ford Credit distributed $275 million to its parent company.
Downgrades remain possible
Both Ford and GM are being monitored for downgrades by S&P and Moody’s Investment Services. Both investment rating companies also have Fiat Chrysler under review, however it could move up depending on its expected merger with French automaker PSA Group.
Fitch Ratings downgraded Ford and GM as well as their financial arms Thursday. GM fell one notch to BBB- from BBB; Ford was lowered to ‘BB+’ from ‘BBB-‘. Both downgrades were based on expectations that credit profile will remain weak for a prolonged period due to the coronavirus pandemic.
Moody’s downgraded Ford from investment-grade to junk status in September, followed by S&P Global Ratings in March, which lowered its credit rating to BB+, one notch below investment grade. GM remains just above junk at Baa3 with Moody’s.
Entering this year, Ford’s debt, excluding its lending arm, was at $15.3 billion, up $1.2 billion from the previous year. That compares to GM at nearly $14.4 billion in 2019, up $423 million from the prior year.
The financing arms typically carry heavy debt, much like a bank. Ford Credit was at about $140 billion to end last year. GM Financial was at $96.5 billion.
S&P said Ford was “borderline for the investment-grade rating before the Covid-19 outbreak,” citing its debt load and lack of competitive position as reasons for the downgrade.
Ford is in the midst of a multi-year $11 billion restructuring plan that kicked off in 2018 that includes spending $7 billion in cash. Ford’s Stone said the plan remains “on track,” however the coronavirus has all automakers reworking their plans unlike any other crisis.
“I never had a business plan that was called pandemic,” Ford CEO and President Jim Hackett told investors on April 28. “I mean that in all sincerity, because we just never imagined the economy turning off. And the other two crises that I was in, we had deep troughs of issues, but this was unique.”