Ford, General Motors On The Chopping Block?

Implications: For years it has seemed that one (or all) of the Detroit Three, Ford, GM or Chrysler could be doomed. None of the companies has been profitable for years. What is the next step?

Analysis:

On top of losing money for years, all three companies have significant debt burdens. As a result, they have taken a pounding from the credit rating agencies. Of the three, Ford leads the pack with a B credit rating from S&P, while GM and Chrysler hold B- ratings, all firmly in junk territory. Remember, there was a time GM had a AAA rating.

So here's the question: could the current credit crisis spell the end of the Detroit Three?

For this discussion, lets focus on GM and Ford, ignoring Chrysler, because it is now privately held, but trust me, the same holds more or less true for them.

For now, both Ford and GM have liabilities greater than their assets, resulting in negative equity. For GM this has been the case since 2006, Ford joined the club this year following their huge 1H loss.

As far as I can tell, creditors are only willing to lend them money, based on the perception that the U.S. government will be forced to intervene. In 2007 GM and Ford generated $182B and $172B in revenues, respectively.

Additionally, Ford employs about 87,700 people, whereas GM employs a whopping 266,000. These are truly huge companies. Also, for each direct job created, approximately six indirect jobs are created. Therefore if these companies were to close their doors tomorrow (not going to happen) it could result in a loss of 2.1 million jobs.

Why are Ford and GM in such bad shape? Well, for starters, they have been losing money for years, but that's not the most serious reason.

As mentioned earlier, both companies show negative equity on their balance sheets. Ford's stands at -$1.7B. GM's equity deficit amounts to -$57B. There is no way they can dig themselves out of this hole. To get back in the black GM would have to make $19B a year, a 14% ROA, with capital expenditures never exceeding depreciation and no dividends paid.

Mind you, the worsening economy is going to impose two distinct problems for GM and Ford, more losses and a more difficult time refinancing. As everyone knows, a seismic shift has taken place in U.S. car buying habits, shifting from gas-guzzling (and highly profitable) SUVs and pickup trucks, to smaller (and less profitable) vehicles.

Naturally, both Ford and GM shifted their production lines to fill the SUV gap. However, it takes time and money to retool an assembly line and introduce new vehicles, two things GM and Ford are short on.

Both Ford and GM are trying to survive by keeping mountains of cash on hand in case their credit lines get pulled and they can't refinance their loans. This may work in the short term, but in the long term their losses may eventually deplete their cash stockpiles.