Sunday, March 8, 2009

GM's Big Assumptions

GMs Big Assumptions

If there's one thing that investors should have learned as a result of the recent credit crisis, it's the danger of accepting inflated numbers—whether they be home prices or advertising pages—as the norm. Newspapers have to accept that they won't be able to return to the day of fat print budgets, and carmakers will have to adapt to a world where only people who can truly afford a new car will buy one.

But there's a lot of disagreement about what that world will look like. And just how big the future car market will be plays a major role in General Motors' (GM) survival. In fact, as its annual filing with the Securities & Exchange Commission made clear on Mar. 4, GM's auditors have "substantial doubt" about the carmaker's ability to continue as a going concern.

That statement may have been routine business for GM's auditors, but the company's plans to return to viability seem to be based on two pretty big assumptions. The first assumption is that there is a bonanza of pent-up demand on the other side of this downturn. The second is that the rebound will be big enough to service the debt that the company will have as it borrows more from the government.

Betting on a Recovery

For the last decade, "all the tools were there to let the market overheat," says Gary Dilts, senior vice-president for J.D. Power's Global Automotive group. "Everything was geared to do that. Now it's geared to not do that."

Just look at the car market. GM and most other automakers think that the current rate of sales—a dismal 9.1 million annualized selling rate in February—will add up to a flurry of car purchases once the economy recovers. By 2012, GM thinks carmakers will once again start selling 16 million cars a year and that could go as high as 18 million.

Maybe pent-up demand will spring loose a bonanza. But analysts are increasingly thinking that even selling 16 million cars and trucks may be a great year, not the norm. J.D. Power thinks consumers will buy between 14 million and 15 million vehicles a year, Dilts says. Ford Motor (F) market analyst George Pipas says 16 million may "be the high watermark." He could well be right.

A Boom Fueled by Cheap Credit

Let's consider a few facts. For the past 10 years, auto sales soared well over 16 million cars and trucks every year. In 2000, at the height of the dot-com boom and when real estate was surging and credit was easy, Americans bought a record 17.8 million vehicles. That was pretty astonishing growth back then when you consider that annual auto sales only crossed 16 million vehicles in the U.S. in 1999 when stock markets were booming. Other than that, car sales were between 12.3 million and 15.5 million for the entire decade of the 1990s.

At the start of the decade, auto executives figured the car market was around 15 million. That was the rule of thumb. With a strong economy or a pitched sales war that led to price cuts, it could go higher. But 15 million vehicles was the benchmark.

Since 1999, Americans have bought a lot more than 15 million every year. They used home equity loans, easy credit from auto finance firms, cheap lease deals, and huge rebates to buy cars even when the one they had was just a few years old. Some people who once could only afford a used car were buying new rides. All of that inflated the car market by about 1 million vehicles a year, says J.D. Power.

Leases and Rental-Car Sales Fall

Many banks won't even do lease deals anymore. GMAC Financial Services does little if any leasing and GM owns a stake in that lender. The banks that are leasing are using tougher terms, so the monthly payments are higher. And home equity? Let's all bow our heads to the passing of home equity.

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