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Update on automakers



July 02, 2013 – Comments (3)

For some years, I've been very cautiously bullish on GM and Ford. On one hand, they escaped the financial/economic crisis by the skins of their teeth. If not for government intervention, GM would not have escaped, period. And of course they're pretty leveraged companies in a highly cyclical industry.

On the other hand, the recession has resulted in a lot of pent up demand for automobiles. For better or worse, we need cars to get around in the United States. The companies both had a huge overcapacity issue, which gave them far too high fixed costs. However, the financial crisis enabled them to shed excess capacity by closing plants, laying off workers and hiring new ones cheaper. And people put off buying vehicles during the recession while population has been growing, making for pent up demand. In a highly leveraged company, that demand can only help disproportionately on the way up (but yes, it's another story on the way down).

Basically, someone who's held GM or Ford stock since 1950 is probably not going to make their money back. But potentially, a new buyer of the stock could make some good money.

Cautious of buying into leveraged companies and getting burned like I did during the financial crisis, I bought Ford convertible preferred stock and Ford TARP warrants in 2010. The convertible preferreds were called, which was unfortunate. The TARP warrants unfortunately expired out of the money, which caused me to lose the premium I paid. In around 2012, I bought GM's TARP warrants.

As the economy in general has rebounded, Ford and GM stock have rebounded, and I've doubled my money on the GM warrants I bought. If I were currently looking to put more money into automakers, I would probably buy straight Ford stock. The economy looks like it will continue to grow slowly, so I am not worried about losing money in these stocks. Ford is in better financial shape than GM. The GM warrants expire in 2018, and I will likely hold these whatever happens to GM (unless it be some sort of material impairment in the company's financial position).

Some will observe that Millenials are less likely to drive than their parents, and that they're much more likely to live in big cities and rely on public transit. This is true. I, for one, hope the trend continues. However, demographic trends play out over considerable lengths of time. Much longer than it will take Ford and GM to recover.

3 Comments – Post Your Own

#1) On July 03, 2013 at 3:15 AM, ikkyu2 (98.17) wrote:

"someone who's held GM or Ford stock since 1950 is probably not going to make their money back"

You need to learn a little bit more about GM before you think about investing. 

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#2) On July 03, 2013 at 2:32 PM, tomlongrpv (54.15) wrote:

I think what ikkyu2 meant to say was that with its bankruptcy, all of GM's pre-bankruptcy shareholders were wiped out such that there is no one who has held the stock since the 1950s.  If bondholdes take a bath you can be sure that equity holders, who are lower in priority in a banlkruptcy get squeezed very hard or even totally out.

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#3) On July 03, 2013 at 7:23 PM, amassafortune (29.18) wrote:

Longer term, you also have the 2-tier labor agreements that will become an issue. Auto worker annual packages used to be worth upwards of $90K ten years ago. As part of the bankruptcy deals (GM & Chrysler, but patterned by Ford),  2-tier agreements brought in new workers at about $14/hr.

Granted, annual bonus money has been better, but at some point younger workers will have enough clout, seniority, and votes to undo some of the big disparity between pre-crisis and post-crisis compensation. 

This is an issue with many city workers across the country, too, and part of the stagnant pay trend. Even with much lower pay for incoming workers, most of the pension funds still have a 30% or better shortfall. 

It could be that once young workers have the votes, they simply take from retirees and give it to themselves without strikes or much affect to the companies or cities. Unions being what they are, they might just try to preserve benefits to retirees and demand everything back they gave up just to get a job in the industry after 2008. 

At the time this happened, I thought of these 2-tier deals as screwing their younger "brothers" rather than accepting a shared sacrifice, but now I see the longer-term value of preserving the established gains of senior union members. The move preserved the higher wage and benefit structure as the auto industry compensation standard.    

The 60 and 72-month auto loans have gained acceptance, bringing much money back to the auto industry and financing arms. 

As an investor, just keep in mind there is no balance sheet liability that shows up for 2nd tier workers, but in the minds of those workers, they expect to be repaid for their sacrifice. 

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