Trend Analysis GM and Toyota 2005—2008

Posted by PITHOCRATES - January 29th, 2013

History 101

GM’s Problems were caused by Franklin Delano Roosevelt and his Ceiling on Wages

The GM bailout is still controversial.  It was part of the 2012 campaign.  It was why we should reelect President Obama.  Because Osama bin Laden was dead.  And General Motors was alive.  But the bailout didn’t fix what was wrong with GM.  Why it went bankrupt in the first place.  The prevailing market price for cars was below their costs.  And what was driving their costs so high?  It was labor.  It was the UAW wage and benefit package that made it impossible for GM to sell a car profitably.

GM’s problems go back to Franklin Delano Roosevelt.  The country was suffering in the Great Depression with double-digit unemployment.  He wanted to get businesses to hire people.  To reduce unemployment.  And pull us out of the Great Depression.  So how do you get businesses to hire more people?  Hmmm, he thought.  Pay people less so businesses have more money to hire more people.  It was brilliant.  So FDR imposed a ceiling on wages.  Why did FDR do this?  Because he was from a rich family who didn’t understand business or basic economics.

Of course there was one major drawback to this.  How do you get the best talent to work for you if you can’t pay top dollar?  Normally the best talent can go to whoever pays the most.  But if everyone pays the same by law you might as well work at the place closest to your house.  Or across from the best bars.  No, if a business wanted the best workers they had to figure out how to get them to drive across town in rush hour traffic and sit in that traffic on the way home.  A real pain in the you-know-what.  So how to get workers to do that if you can’t pay them more?  You give them benefits.

Toyota doesn’t have the Legacy Costs that Bankrupted an Uncompetitive GM

And this was, is, the root of GM’s problems.  Those generous pension and health care benefits.  Things we once took care of ourselves.  Before our employers started providing these.  And the UAW really put the screws to GM.  Getting great pay, benefits and workplace rules.  For both active workers.  And retirees.  Even laid-off workers.  Such as the job bank.  Where GM paid workers who had no work to do.  It’s benefits like this that have bankrupted GM.  Especially the pensions and health care costs for retired workers.  Who outnumbered active workers.  Those people actually assembling the cars they sell.

It’s these legacy costs that have made GM uncompetitive.  Toyota, for example, didn’t suffer the FDR problem.  So their costs for retired workers don’t exceed their costs for active workers.  In fact let’s compare GM and Toyota for the four years just before GM’s government bailout (2005-2008).  We pulled financial numbers from their annual reports (see GM 2005 & 2006, GM 2007 & 2008, Toyota 2005 & 2006 and Toyota 2007 & 2008).  We’ve used some standard ratios and plotted some resulting trends.  Note that this is a crude analysis that provides a general overview of the information in their annual reports.  A proper analysis is far more involved and you should not construe that the following is an appropriate way to analyze financial statements.  We believe these results show general trends.  But we offer no investment advice or endorsements.

GM Toyota Current Ratio

We get the current ration by dividing current assets by current liabilities.  These are the assets/liabilities that will become cash or will have to be paid with cash within 12 months.  If this ratio is 1 it means current assets equals current liabilities.  Meaning that a business will have just enough cash to meet their cash needs in the next 12 months.  If the number is greater than 1 a business will have even a little extra cash.  If the number is less than 1 a business is in trouble.  As they won’t have the cash to meet their cash needs in the next 12 months.  Unless they borrow cash.  Toyota’s current ratio fell slightly during these 4 years but always remained above 1.  Falling as low as 1.01.  Whereas GM’s current ratio was never above 1 during these 4 years.  And only got worse after 2006.  Showing GM’s financial crash in 2008.

The GM Bailout did not address the Cause of their Bankruptcy—UAW Pensions and Health Care Benefits

There are two basic ways to finance a business.  With debt.  And equity.  Equity comes from outside investors (when a business issues new stock).  Or from profitable business operations.  Which typically accounts for the majority of equity.  Profitable business operations are the whole point of running a business.  And it’s what raises stock prices.  To see which is providing the financing of a business (debt or equity) we calculate the debt ratio.  We do this by dividing total liabilities by total assets.  If this number equals 1 then total assets equal total liabilities.  Meaning that 100% of a business’ assets are financed with debt.  And 0% with equity.  Lenders do not like seeing this.  And will be very reluctant to loan money to you if your business operations cannot generate enough profits to build up some equity.  And that was the problem GM had.  Their business operations could not generate any profits.  So GM had to keep borrowing.

GM Toyota Debt Ratio

GM went from bad to worse after 2005.  Their debt ratio went from 1.02 in 2006.  To 1.24 in 2007.  And to 1.94 in 2008.  Indicating massive borrowings to offset massive operating losses.   And how big were those losses?  They lost $17.806 billion in 2005.  $5.823 billion in 2006.  $4.309 billion in 2007.  And in the year of their crash (2008) they lost $21.284 billion.  Meanwhile Toyota kept their debt ratio fluctuating between 0.61 and 0.62.  Very respectable.  And where lenders like to see it.  As they will be more willing to loan money to a company that can generate almost half of their financing needs from profitable business operations.  So why can’t GM?  Because of those legacy costs.  Which increases their cost of sales.

GM Toyota Cost of Sales

GM’s cost of sales was close to 100% of automotive sales revenue these 4 years.  Even exceeding 100% in 2008.  And it’s this cost of sales that sent GM into bankruptcy.  Toyota’s was close to 80% through these 4 years.  Leaving about 20% of sales to pay their other costs.  Like selling, general and administrative (S,G&A).  Whereas GM was already losing money before they started paying these expenses.  Thanks to generous UAW pay and benefit packages.  The job bank.  And the even greater costs of pensions and health care for their retirees.  It’s not CEO compensation that bankrupted GM.  It was the UAW.  As CEO compensation comes out of S,G&A.  Which was less than 10% of sales in 2007 and 2008.  Which was even less than Toyota’s.

GM Toyota S G and A

GM’s costs kept rising.  But they couldn’t pass it on to the consumer.  For if they did the people would just buy a less expensive Toyota.  So GM kept building cars even though they couldn’t sell them competitively.  And sold them at steep discounts.  Just to make room for more new cars.  So the UAW could keep building cars.  Incurring massive losses.  Hoping they could make it up in volume.  But that volume never came.

GM Toyota Automotive Sales as percent of 2005

Toyota continued to increase sales revenue year after year.  But GM’s sales grew at a flatter rate.  Even falling in 2008.  It was just too much.  GM was such a train wreck that it would have required a massive reorganization in a bankruptcy.  Specifically dealing with the uncompetitive UAW labor.  Especially those pensions and health care benefits for retirees.  Which the government bailout did not address.  At all.  The white collar workforce lost their pensions.  But not the UAW.  In fact, the government bailout went to bolster those pension and health care plans.  So the underlying problems are still there.  And another bankruptcy is likely around the corner.


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