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Big Three Have Five Years of Prosperity Until Party Ends


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Big Three Have Five Years of Prosperity Until Party Ends

by John McElroy (RSS feed) on Dec 2nd 2010 at 2:28PM

Signs To Watch For As The Cycle Repeats

Detroit's automakers are starting to beat their chests in exultation, and who can blame them? The last 16 months have been nothing short of a miracle. Who would have believed they could recover so quickly?

Dial back the clock to last summer, June of 2009. Chrysler had just clawed its way out of bankruptcy, GM was still bankrupt. And Ford just barely avoided filing, saved only by borrowing heavily before the credit market collapsed.

The good times are just getting going. The next five years could be phenomenal. If someone had come up to you then and said that in less than a year Ford would be earning over $7 billion and that it would surpass Toyota and Honda in quality, you would have said it was not going to happen.

If they had told you that General Motors would be earning over $6 billion in profits, you would have called them crazy.

If they had told you Chrysler would report an operating profit and come within a whisker of catching Honda in market share, you would have said they're mad.

And if they had told you that Toyota would be battered by criticism for all its defects and quality problems, you would have said that's impossible.

But here we are a year and a half later and the American auto industry has been completely transformed. The Big Three are more competitive than they've been in nearly four decades. Even more amazing, the good times are just getting going. The next five years could be phenomenal.

John McElroy is host of the TV program "Autoline Detroit" and daily web video "Autoline Daily". Every week he brings his unique insights as a Detroit insider to Autoblog readers.

Think about it. If Ford and GM can rake in boatloads of money when the U.S. market is running at dismally low sales levels, imagine how much money they can make as the market recovers. If Chrysler can gain market share on Honda with a crappy line-up, imagine what it can do as it places competitive products in its showrooms. Equally significant: As the Big Three recover, they're pulling their suppliers up with them. A rising tide raises all boats. The Motor City is going to rock and roll like no one would have believed possible.

How will we know if the Big Three are losing their way again? It's not because, as some environmentalists argue, the Obama Administration is finally forcing the Big Three build the small cars that America wants. Don't you believe that fairy tale. Last month truck sales hit 53% market share, the same as in their heyday. And that's not just contractors buying more pick-ups. It's the entire truck market. Even Mercedes and BMW are bragging about how hot their SUVs are selling.

Even so, be careful. This has always been a cyclical business, and there's no reason to believe the cycle has been broken. So how will we know if the Big Three are losing their way again? Here are some pointers.

If the UAW forces a strike at Ford to get back many of the concessions that made Ford competitive, you'll know they're re-sowing the seeds of destruction. By the way, it's easy to predict Ford will be the strike target. As part of the bankruptcy deal, the UAW is legally prohibited from striking GM and Chrysler until 2014.

Keep a close eye on day's supply. If the Big Three let their inventory drift above 60 days' for extended periods of time, you'll know they're losing their cost discipline. Management likes to increase production to boost revenue, even if it penalizes them down the road. It's a sign of short-term thinking, and a move that could force them back into costly sales incentives.

Sometime around 2015 this party will come to an end.

Watch the ratio of cost-of-sales to revenue. If the Big Three let their costs rise as a percent of revenue, that means their break-even point is going up, and that the profitability of their core operations is on the decline.

Beware of their debt levels, and make sure they have a solid balance sheet with short term assets exceeding short term liabilities. You never want to invest in an automaker that owes more than it owns.

Run for the hills if you hear top management bragging about how good a job they're doing. That's the first step in self-delusion. The second step is justifying cost-cutting measures to cheapen the product. That's when you'll know they're back to their former destructive ways.

But at this snapshot in time, the planets are in perfect alignment. The Big Three are going to make more money than they ever have in their history. And yet, I figure that sometime around 2015 this party will come to an end, as supply and demand come into equilibrium.

Five years, that's all we got. Let's just hope that this time Detroit maintains a healthy war chest, because that's when I figure the Chinese will decide it's time to get seriously involved in the American market.



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