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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U.S. Tax Dollars being Invested to Create Jobs in China

Posted by PITHOCRATES - December 1st, 2012

Week in Review

The U.S. government bailed out GM.  Instead of letting them go through a normal bankruptcy proceeding that would make GM competitive again so they could sell cars in the U.S. again.  Instead, the government gave GM taxpayer money to fund their pension and retiree health care costs.  Which will do nothing to improve their competitiveness.  Or create new jobs in the U.S.  So what will that massive government investment do for GM?  Allow them to expand and create jobs…in China (see GM Chinese venture to build $1 billion plant in Chongqing by Ben Klayman posted 11/28/2012 on Reuters).

General Motors Co (GM.N) and its Chinese joint-venture partners said on Wednesday they plan to build a $1 billion auto assembly plant in the city of Chongqing as the GM group bids to remain the leader in the world’s largest auto market…

Earlier this month, GM and its Chinese partners opened a plant in the southern city of Liuzhou for its low-cost Baojun brand. That plant will also eventually have an annual production capacity of 400,000 vehicles…

In September, GM opened a large vehicle test track west of Shanghai. GM and its partners invested $252 million to build what officials called the country’s largest proving ground.

In addition to Liuzhou, the joint venture currently operates a plant in Qingdao. GM and SAIC, through a different joint venture, also have a plant in Shanghai, and several more in northeast China.

This is not helping the U.S. economy.  Building plants and creating jobs in China.  All this is doing is allowing GM to make money like Wall Street makes money.  By investing money.  And getting a return on their Chinese investments.  Government Motors, I mean, General Motors is doing the very thing the Democrats hammered Mitt Romney for doing during the 2012 election.  Creating jobs in China.  The only difference, of course, is that Romney didn’t use U.S. tax money to create any of his jobs.

So the government bailout of General Motors didn’t help anyone but the UAW whose high costs were making them uncompetitive (the source of all of GM’s problems).  And the Chinese.  It didn’t create any new jobs in America.  And it didn’t help GM become more competitive.  Forcing them to rely on their Chinese job growth because their cost structure just won’t let them sell more cars or add more jobs in the United States.

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FDR, Wage Ceiling, Arsenal of Democracy, Benefits, Big Three, Japanese Competition, Legacy Costs, Business Cycle and Bailouts

Posted by PITHOCRATES - February 14th, 2012

History 101

After the Arsenal of Democracy defeated Hitler the Wage Ceiling was Gone but Generous Benefits were here to Stay

FDR caused the automotive industry crisis of 2008-2010.  With his progressive/liberal New Deal policies.  He placed a ceiling on employee wages during the Great Depression.  The idea was to keep workers’ wages low so employers would hire more workers.  It didn’t work.  And there was an unintended consequence.  As there always is when government interferes with market forces.  The wage ceiling prevented employers from attracting the best workers by offering higher wages.  Forcing employers to think of other ways to attract the best workers.  And they found it.  Benefits.

Adolf Hitler ended the Great Depression.  His bloodlust cut the chains on American industry as they tooled up to defeat him.  The Arsenal of Democracy.  America’s factories hummed 24/7 making tanks, trucks, ships, airplanes, artillery, ammunition, etc.  The Americans out-produced the Axis.  Giving the Allies marching towards Germany everything they needed to wage modern war.  While in the end the Nazis were using horses for transport power.  This wartime production created so many jobs that they even hired women to work in their factories.  Bringing an end to the Great Depression finally after 12 years of FDR.

The Arsenal of Democracy defeated Hitler.  U.S. servicemen came home.  And the women left the factories and returned home to raise families.  With much of the world’s factories in ruins the U.S. economy continued to hum.  Only they were now making things other than the implements of war.  The auto makers returned to making cars and trucks.  The ceiling on wages was gone.  But those benefits were still there.  Greatly increasing labor costs.  But what did they care?  The American auto manufacturers had a captive audience.  If anyone wanted to buy a car or truck there was only one place to buy it.  From them.  No matter the cost.  So they just passed on those high wages and expensive benefit packages on to the consumer.  Times were good.  The Fifties were happy times.  Good jobs.  Good pay.  Free benefits.  Nice life in the suburbs.  All paid for by expensive vehicle prices.

The Big Three could not Sell Cars when there was Competition because of their Legacy Costs

But it wouldn’t last.  Because it couldn’t last.  For those factories destroyed in the war were up and running again.  And someone noticed those high prices on American cars.  The Japanese.  Who rebuilt their factories.  Which were now humming, too.  And they thought why not enter the automotive industry?  And this changed the business model for the Big Three (GM, Ford and Chrysler) as they knew it.  The Big Three had competition for the first time.  Their captive audience was gone.  For the consumer had a choice.  They could demand better value for their money.  And chose not to buy the ‘rust buckets’ they were selling in the Seventies.  Cars that rusted away after a few snowy winters.  Or a few years near the ocean coast.

The new Japanese competition started about 30 years after U.S. workers began to enjoy all those benefits.  So the U.S. car companies paid their union auto workers more and gave them far more benefits than their Japanese competition.  And those early U.S. workers were now retiring.  Giving a great advantage to the Japanese.  Because those generous benefits provided those U.S. retirees very comfortable pensions.  And all the health care they could use.  All paid for by the Big Three.  Via the price of their cars and trucks.

Well, you can see where this led to.  The Big Three could not sell cars when there was competition.  Because of these legacy costs.  Higher union wages.  Generous pension and health care benefits that workers and retirees did not contribute to.  (By the time GM and Chrysler faced bankruptcy in 2010 there were more retirees than active union workers).  The United Automobile Workers (UAW) jobs bank program where unemployed workers (laid off due to declining sales) collected 95% of their pay and benefits.  (You can find many quotes on line from a Detroit News article stating some 12,000 UAW workers were collecting pay and benefits in 2005 but not working.)  The Japanese had none of these costs.  And could easily build a higher quality vehicle for less.  Which they did.  And consumers bought them.  The Big Three conceded car sales to the Japanese (and the Europeans and South Koreans) and focused on the profitable SUV and truck markets.  To pay these high legacy costs.  Until the gas prices soared to $4/gallon.  And then the Subprime Mortgage Crises kicked off the Great Recession.  Leading to the ‘bankruptcy’ of GM and Chrysler.  And their government bailouts.

The U.S. Automotive Government Bailout cut Wage and Benefits once Set in Stone

The Big Three struggled because they operated outside normal market forces.  Thanks at first to a captive audience.  Then later to friends in government (tariffs on imports, import quotas, union-favorable legislation, etc.).  All of this just delayed the day of reckoning, though.  And making it ever more painful when it came.

During economic downturns (when supply and prices fall) their cost structure did not change.  As it should have.  Because that’s what the business cycle does.  It resets prices and supply to match demand.  With recessions.  Painful but necessary.  Just how painful depends on how fast ‘sticky’ wages can adjust down to new market levels.  And herein lies the problem that plagued the Big Three.  Their wages weren’t sticky.  They were set in stone.  So when the market set the new prices for cars and trucks it was below the cost of the Big Three.  Unable to decrease their labor (wage and benefit) costs, profits turned into losses.  Pension funds went underfunded.  And cash stockpiles disappeared.  Leading the Big Three to the brink of bankruptcy.  And begging for a government bailout.

Well, the bailout came.  The government stepped in.  Gave the union pension fund majority control of the bailed out companies.  Screwing the bondholders (and contract law) in the process.  And created a two-tier labor structure.  They grandfathered older employees at the unsustainable wage and benefit packages.  And hired new employees at wage and benefit packages that the market would bear.  Comparable to their Asian and European transplant auto plants in the right-to-work states in the southern U.S. states.  And put the market back in control of the U.S. auto industry.  For awhile, at least.

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