Do Americans Want To Buy Fuel Efficient Cars?

There appears to be debate on this question, which is puzzling to me. I think many people are mistakenly under the assumption that “small, fuel efficient” cars equate to miniature so called “smart” cars that we see every so often on the road and in Europe, as opposed to simply something other than a gas guzzling SUV or crossover vehicle. In fact, most sedans today are very fuel efficient.

Will U.S. consumers buy these cars? Well, that question has actually already been answered. As you can see from the chart below, the top 5 best selling cars in the U.S. get more than 30 miles per gallon on the highway, and #6 on the list isn’t too far behind:

Trucker YRC Applies for TARP Funds, Don’t Hold Your Breath

For those who don’t know, YRC Worldwide (YRCW) is the former Yellow Roadway. Here is some of what the Wall Street Journal is reporting:

“YRC Worldwide Inc., one of the nation’s largest trucking companies, will seek $1 billion in federal bailout money to help relieve pension obligations, the chief executive said Thursday. Chief Executive William Zollars said the company will seek the money to help cover the cost of its estimated $2 billion pension obligation over the next four years. Under a complicated system that Mr. Zollars labeled unfair, roughly half of YRC’s contributions to a multi-employer union pension fund cover the costs of retirees who never worked for the Overland Park, Kan., company.”

Awfully presumptuous of him, don’t you think, applying as a trucking company without any indication Treasury would ever widen TARP to include any U.S. corporation? I would be shocked if this were approved, and if somehow it is, TARP would be completely out of control.

“Mr. Zollars declined to comment on YRC’s specific strategy in seeking the funds, other than to say the company shouldn’t be forced to pay the pension benefits of employees who never worked for YRC.”

This seems like an odd explanation. I don’t know the details of the “complicated, multi-union” pension plan in question, but it strikes me as probable that if half of YRC’s contribution goes to people who didn’t work for YRC, then the other truckling companies are in the same boat and are paying for some of YRC’s former employees. Does Zollars want to stop paying for non-YRC pensions while still having his competitors subsidize YRC’s pension obligations? The whole thing is bizarre, to say the least.

Full Disclosure: No position in YRCW at the time of writing, but positions may change at any time

Why I Have No Problem With The Government Firing Rick Wagoner

Call me skeptical that since the Obama administration’s auto task force ousted General Motors CEO Rick Wagoner it means the government is going to take over and ruin the auto industry. I think Wagoner’s list of accomplishments (or lack thereof) shows that he deserved to be gone long ago. After all, GM stock went from $60 to $2 under his tenure as CEO.

As for whether the government should have the right to force him out, why shouldn’t they have the same power that any other creditor or investor would have when trying to help a company avoid bankruptcy? Private equity invests in distressed companies all the time and as a condition of such investments always has a say in the turnaround plan, including replacing a chief executive. Having such power is the only way they feel comfortable that adequate changes will be made to somewhat protect their investment.

The government is unfortunately in the drivers seat in this case because nobody else will come to GM’s aid in its current form. By doing so, however, they should have the same rights as anybody else. No more, no less. Whether they should have even tried to prevent a GM bankruptcy is another question entirely, and a very valid one at that. I have no problem with someone arguing against that, but that really has nothing to do with the Wagoner situation.

The Obama team has decided to continue the public aid that the Bush team started, probably to try and avoid further destabilizing the financial system and economy. Reasonable minds can (and are) disagree over whether that is the right thing to do or not, but Rick Wagoner had to go regardless. Don’t forget, under his leadership, even when the economy was booming GM North America was in the red.

What about Wagoner’s replacement, Fritz Henderson? Well, I don’t think the government had a hand in choosing him. He openly and proudly announced that he was a lifelong GM’er and that Rick Wagoner was his mentor. Yikes, I guess the jury is still out on whether that is change we should believe in or not.

Full Disclosure: No position in GM at the time of writing, but positions may change at any time (I don’t expect this to change in this case)

General Motors Fighting Uphill Battle with Double Edged Sword

Shortly after the U.S. government lent the Big Three $17.4 billion, we learned Monday that an additional $6 billion of taxpayer money is headed to GMAC, the large General Motors finance arm. Where will this money go? Well, GMAC said Tuesday that it will immediately resume automobile financing for “a broader spectrum of U.S. customers.” That is code for “we are going to lend money to people who probably should not be getting it right now.”

If you think this sounds awfully strange given the current economic situation, you would be right. GMAC got into trouble in the first place by giving out loans to sub-prime borrowers for not only car loans, but mortgages as well (Ditech is owned by GMAC, for example). To stem bad loans, earlier this year GMAC increased its minimum required credit score to 700. This compared to the median credit score nationally of 723, so more than half the country qualified even after lending standards were tightened considerably.

Not surprisingly, auto sales sank after the new minimums were implemented, but I think it is unreasonable to attribute all of that decline to the new credit standards. The economy is bad, people are cutting back, and unemployment is soaring, so there are simply fewer people who can afford to buy new cars, regardless of what their credit score is.

As car inventories build and GM’s losses mount, the only way to boost sales is to lend to less creditworthy borrowers. GMAC said Tuesday it will modify its credit criteria to include buyers with a credit score of 621 or higher.

This appears to be a slippery slope. Lending to borrowers with bad credit as a means to increase profits is exactly how we found ourselves in a sub-prime mortgage meltdown in the first place. With the economy worsening, this hardly seems like the time to loosen credit standards. Not only that, but doing so almost ensures that increased profits earned from higher car sales volumes will be offset by higher credit losses because GM funds the majority of its car sales through GMAC, its own financing division.

While I do not own GM stock, what is going on here should matter to all of us because taxpayer money is being used. We essentially just gave GMAC $6 billion which it is using to lend to borrowers with credit scores as much as 100 points lower than the national average. Such a plan can’t possibly increase the odds that the government gets its money back on these emergency loans. Since Uncle Sam will be first in line to collect its money, GM shareholders are likely to be left with very little unless the company sincerely changes its ways. As this week’s news is more of the same, I have no interest in going near GM stock.

Full Disclosure: No position in General Motors at the time of writing, but positions may change at any time

Update (12/31): Barry Ritholtz points out that GMAC doesn’t even know what a sub-prime borrower is.

Sears Holdings Has Squandered An Opportunity

The last four years or so for Sears Holdings (SHLD) and its shareholders would make for quite an interesting Harvard Business School case study. I have been writing about the company since 2005 and was an early investor in Kmart, even before Eddie Lampert used it as a vehicle to buy Sears.

The early success was very impressive. Lampert bought loads of Kmart debt as it filed bankruptcy and gained control of the company’s equity when it reemerged in 2004. In 2006 Sears Holdings earned a profit of $1.5 billion, or $9.58 per share, quite a turnaround for a retailer that had been bleeding red ink.

Lampert accomplished this not by turning Sears and Kmart into strong retailers like Wal-Mart (WMT) and Target (TGT) (sales and profit margins still lagged those competitors), but rather simply by running the companies very efficiently and milking them for cash flow. Even if you earn a 3% margin instead of 6%, that is big money when you bring in $50 billion of sales annually.

The Wall Street community was sold on the idea that Lampert would use the cash flow from Sears Holdings to diversify its business away from ailing retail brands. Maybe he would close down stores and sell the real estate, or lease it back to other retailers who wanted the space. Maybe Kenmore and Craftsman products, which are owned by Sears, would show up on other retailers’ shelves. Maybe Land’s End, also owned by Sears, would be expanded as an independent retail brand. Maybe Lampert would buy other companies outside of retail altogether. The possibilities seemed, were, and still are, endless.

And yet none of this has materialized. Sears continues to operate as a sub-par retailer and uses excess cash flow to repurchase stock. As the economy has faltered, so has cash flow. Adjusted EBITDA year-to-date has fallen to $700 million, from $1.5 billion last year. The only positive has been the reduction in share count. Sears earned $1.5 billion in 2006, or $9.58 per share. If they somehow are able to earn that much again when the retail environment improves, earnings per share would be nearly $12 per share because of the lower share count. With the stock at $31 today, you can see that the stock would trade back above $100 in that scenario.

But how will that happen anytime soon if Sears continues as is has? It won’t, which is why Peridot Capital has been steadily selling Sears stock over the last year. It used to be a very large holding, but is now one of our smallest. Eddie Lampert evidently was convinced he could do more with the retailer’s operations even after the low hanging fruit had been picked. That was a bad decision.

As long as the economy remains weak, Sears will likely use it as an excuse for its poor operating results. That is a shame, because they had a perfect opportunity to diversify out of retail and they chose not to, even when it was widely accepted as the right strategy for investors. The truth is, however, that Sears and Kmart are not strong retailers and likely never will be, at least not in their current form.

To me, Sears is in the same exact position as General Motors (GM) right now. They are operationally inferior to their competitors, but refuse to dramatically alter their business plans to adapt to the market. Today the Big 3 CEOs will testify in front of Congress and explain that the economy is the source of their problems. They need annual auto sales of 13 million units to earn a profit, far from the 10 to 11 million run rate we are now facing.

I don’t need to tell you that GM’s business model is the problem, not the economy. If the U.S. auto market shrinks due to higher job losses and tighter credit standards, managers need to make changes to ensure they can survive in such an environment. In that case, a stronger economy would mean higher profits, not just survival.

I heard a GM dealer on television complaining that he can finance customers with credit scores of 650 or higher today, whereas last year someone with a 550 could get a loan. He implied that the banks were at fault for cutting credit for people with bad credit (the average credit score in the U.S. is 680). Was it not the fact that 550 credit scores qualified for car loans in the first place that got us into this kind of financial crisis? We should give loans to low quality borrowers to save the Detroit auto industry? I think not.

The bottom line is, if your company adapts you will likely be a survivor. When times are bad the weak die out and the strong not only survive, but they come out of the downturn even stronger than they were before. In today’s market, when nearly every stock is down tremendously, there are fewer reasons to invest in Sears or GM when you can buy a stronger company like Target or Toyota on sale. When Target fetched a 20 P/E I preferred to buy the more undervalued Sears. Combine disappointing execution by Sears and a 50% drop in Target stock, and given the same choice I will take Target at a 10 P/E, which is what I plan to do.

Full Disclosure: At the time of writing Peridot Capital was long shares of Sears and Target and had no position in GM or Wal-Mart, but positions may change at any time

Airline CEOs: Hedge Your Fuel Costs Now

We have seen crude oil prices fall 50% from $150 to $75 per barrel. Aside from Southwest Airlines (LUV), my preferred air carrier for many years (for traveling, not investing), the other airlines missed the boat on hedging fuel costs and paid the price as the oil spike wiped away their profits after the last round of bankruptcies. If they were smart, they would begin hedging right now. Given the economic problems we are facing and the fear of a global economic recession, oil is on sale due to temporary factors and global demand is still growing (more on this in coming days).

Sure,oil could get even cheaper in 2009 as the economy weakens, but that would be the time to increase the hedges further as prices fall. Once the economy rebounds we will see $100 oil again and those who hedged will look very smart. Legacy carrier CEOs might not be used to being called smart, but they certainly should give it a try.

If any airline workers are reading this, pass along this advice to your bosses. Airline CEOs: start hedging your fuel costs now and increase them should oil prices continue to fall during the recession. Global oil demand is not going to start falling anytime soon, and falling gas prices today are just going to reaccelerate the demand growth that has fueled the commodity bull market.

Full Disclosure: No position in Southwest Airlines stock at the time of writing, but positions may change at any time. I do, however, have a Southwest Visa card in my wallet.

Contrarian Call: 40% Drop in Boeing Shares Looks Overdone

The decline in shares of Boeing (BA) has been significant over the last year. The stock has fallen 40% from $107 to $64 as high oil prices force most domestic airlines into heavy losses. The market appears to be acting as though Boeing’s only customers are domestic airlines. If that were the case, one could certainly argue near-term earnings growth would be non-existent and the stock deserves the severe haircut it has seen (BA trades at 12 times trailing earnings, 11 times 2008 estimates, and 9 times 2009 estimates).

Boeing – One Year Chart:

Investors need to keep in mind that Boeing will get 50% of its revenue from its Integrated Defense Systems (IDS) division this year, with the rest coming from commercial aircraft. The growth in the aircraft segment is coming from overseas, not the United States. With global economies growing faster than ours, much of the 95% of the world population not living in the U.S. are beginning to either fly more or fly for the first time. Countries like China, India, and the UAE are ordering more and more places from Boeing to boost their fleets. Boeing is not a one trick pony by any means.

The company has also been hit due to delays in its new 787 Dreamliner, its next generation plane. Wall Street obsesses over short term events, so a delay of a few months will hit the stock, but in reality, long term investors should feel confident that Boeing has a new product cycle coming. New planes cost more than the old ones and the 787 improves fuel efficiency dramatically, which is a great feature with high oil prices. Even with some delays with a project this big, Boeing’s earnings should still accelerate after the 787 starts being delivered.

Boeing appears to be an excellent contrarian investment option after a 40% drop in stock price. There are clearly issues facing the company, but the current valuation, I believe, has factored in most of the negativity. Even if 2009 profit projections turn out to be too optimistic (current consensus is $6.93 per share), the stock looks very cheap. Even if earnings only reach $6, Boeing at $63 trades at only 10.5 times forward earnings and yields 2.5%. That is a pretty meager valuation for a company that, combined with Airbus, dominates the aircraft market and has a strong defense business in a volatile geopolitical climate.

As a result, Boeing will be added to the Blog Model Portfolio after the market close today.

Full Disclosure: Long shares of Boeing at the time of writing

Merrill Lynch Somehow Cuts Target Price on GM by 75% in 1 Day

Academic studies have found that Wall Street analyst stock recommendations trail the market and do so with more volatility. As a result, investors who use sell side research should be careful to pay attention to certain data points that analysts have spent hours putting together, but to completely ignore price targets and ratings and instead coming up with their own opinion on the ultimate value of a stock.

The latest example that illustrates this point is the call we got out of Merrill Lynch today. ML’s auto analyst downgraded shares of General Motors (GM) from “buy” to “sell” and slashed the price target from $28 to $7 per share. That’s right, this analyst thinks GM is worth 75% less than it was 24 hours ago.

As for how to value GM, I think it is simply too difficult to do so. It is nearly impossible to estimate future legacy costs, and trying to figure out what a reasonable profit margin on cars should be is simply a guess because they are not even making money at all and their competitive position has deteriorated since they were last in the black.

Besides, if an analyst can tweak their model and get $28 one day and $7 the next, that is a pretty clear signal to me that valuing GM right now is just not something anyone can do with a large degree of confidence.

Anybody think GM is a buy at 10 bucks? If so, why?

Full Disclosure: No position in GM at the time of writing

Honda Previews Future of Compact Vehicles

It will take time, but this kind of introduction shows we do have the ability to transform our domestic vehicle fleet in order to greatly reduce oil consumption from transportation, which represents the vast majority of our energy use. As 5% of the world’s population using 25% of the world’s oil, even a 10 or 20 percent drop in our consumption would meaningfully impact the global supply and demand picture for crude oil, which is hitting new highs today at nearly $140 per barrel.

From the Associated Press:

Honda rolls out new zero-emission car
Monday June 16

TAKANEZAWA, Japan (AP) — Honda’s new zero-emission, hydrogen fuel cell car rolled off a Japanese production line Monday and is headed to Southern California, where Hollywood is already abuzz over the latest splash in green motoring.

The FCX Clarity, which runs on hydrogen and electricity, emits only water and none of the noxious fumes believed to induce global warming. It is also two times more energy efficient than a gas-electric hybrid and three times that of a standard gasoline-powered car, the company says.

Japan’s third biggest automaker expects to lease out a “few dozen” units this year and about 200 units within three years. In California, a three-year lease will run $600 a month, which includes maintenance and collision coverage.

The fuel cell draws on energy synthesized through a chemical reaction between hydrogen gas and oxygen in the air, and a lithium-ion battery pack provides supplemental power. The FCX Clarity has a range of about 270-miles per tank with hydrogen consumption equivalent to 74 miles per gallon, according to the carmaker.

The 3,600-pound vehicle can reach speeds up to 100 miles per hour.

John Mendel, executive vice president of America Honda Motor Co., said at a morning ceremony it was “an especially significant day for American Honda as we plant firm footsteps toward the mainstreaming of fuel cell cars.”

The biggest obstacles standing in the way of wider adoption of fuel cell vehicles are cost and the dearth of hydrogen fuel stations. For the Clarity’s release in California, Honda said it received 50,000 applications through its website but could only consider those living near stations in Torrance, Santa Monica and Irvine.

Initially, however, the Clarity will go only to a chosen few starting July and then launch in Japan this fall.

Spallino, who currently drives Honda’s older FCX and was also flown in for the ceremony, said he will use the Clarity to drive to and from work and for destinations within the Los Angeles area. The small number of hydrogen fuel stations is the “single limiting factor” for fuel cell vehicles, he said.

“It’s more comfortable, and it handles well,” said Spallino of Redondo Beach. “It’s got everything. You’re not sacrificing anything except range.”


Are Legacy Costs Really AMR’s Biggest Problem?

Rubens writes:

“Can you give some specific advice to the big airlines on how they can cut costs and become profitable? I don’t think you really understand their situation. To compare the big airlines with the budget ones is like comparing a Ford and GM plant with a Toyota one. Ford and GM has massive legacy costs of high salaries and benefits, and so do the big airlines. American is one of the few (or is it the only one?) of the big airlines that hasn’t filed for Chapter 11 in recent years, which would have let them reduce costs and renegotiate legacy employee agreements.”

Thank you for the comment, Rubens.

Unfortunately, it simply isn’t true that legacy costs are the problem for American. In fact, Southwest actually spent more on wages, salaries, and benefits than American did in the first quarter.

As you can see from the Q1 summary below, American’s cost structure is higher than Southwest despite the fact that they spend less than Southwest on compensation expense. The difference in fuel costs is due to Southwest’s hedges (which tapers off over time) and it is too late to hedge those now.

However, AMR operating losses in Q1 amounted to 3.3% of sales, which just so happens to be the difference in “other” operating costs. So, if AMR could simply get their non-fuel cost structure in line with Southwest’s, they would have broken even in the first quarter.

UPDATE: I left off one statistic I meant to include. AMR employs 152% more people (85,500) than Southwest does (33,895) yet AMR only has 125% more in revenue. So staffing levels are another area they could cut to get their revenue per employee ratio down.

Full Disclosure: No positions in the companies mentioned at the time of writing