US automakers at the brink as oil surges

For two years, U.S. automakers have told investors, creditors and workers to remain patient with a wrenching, industry-wide restructuring because a turnaround was just around the corner.

But with oil prices surging, the U.S. auto market bumping along at near-decade lows and ever more Americans defecting from trucks and sport utility vehicles, a new risk looms for Detroit: the future may be slipping out of its control.

Ford Motor Co's warning on Thursday that it would miss its goal of returning to profitability in 2009 underscored the growing economic pressure on the battered industry.

For now, Ford, General Motors Corp and Chrysler LLC have the cash and credit to weather a continued slump as they play for time by selling more assets and raising financing, according to equity and credit analysts.

They have some levers to pull and some time to work it out, said Pete Hastings, a bond analyst with Morgan Keegan.

But if the U.S. auto market fails to bottom out in 2008 or if oil prices rise unabated, the threat of failure grows in an industry struggling with a third straight year of lower sales.

Toyota Motor Corp and Nissan Motor Co have also both warned that the U.S. industry would hurt results, but both remain profitable and neither relies as heavily on truck sales as the Detroit Three.

In the meantime, U.S. gasoline prices have been climbing steadily, and as the average price crossed $3.50 per gallon this month, Ford saw signs of worse trouble ahead.

We saw a real change in the industry demand for pickup trucks and SUVs in the first two weeks of May, Ford Chief Executive Alan Mulally said. It seemed to us that we reached a tipping point where customers began shifting away from these vehicles at an accelerated rate.

Or as Erich Merkle, director of forecasting for consulting firm IRN Inc, put it: What we are seeing is a massive rotation out of trucks and into cars.

As of April, GM, Ford and Chrysler had already seen their combined share of the U.S. market slip below 50 percent. By contrast, at its recent peak in 1980, GM alone had 45 percent.

But Toyota overtook Ford as the number-two player in the U.S. market in 2007, and Honda Motor Co is on track to unseat Chrysler as number three.

Driving that gain is the market-leading fuel economy of Honda's fleet and a line-up that relies on light trucks for about 43 percent of sales versus Chrysler's 68 percent.

In the short term, all three companies will suffer from misaligned product portfolios, Fitch Ratings Managing Director Mark Oline said.

Peter Morici, a University of Maryland economist and a critic of the strategic thinking in Detroit, questioned whether the crisis had fully sunk in, even now.

It is a question in my mind whether Chrysler and Ford will both be around and I don't know that management at either place has fully reckoned with that reality and built that into their thinking -- that they are really in a survival mode, not a fix mode, Morici said.

WRONG PLACE AT THE WRONG TIME

U.S. auto sales are on track to drop as low as 15 million units this year, a sharp contraction from 16.15 million a year earlier that none of the major automakers had called heading into 2008. Now the focus is on the prospects for 2009 as hopes fade for a second-half recovery.

John Hoffecker, managing partner at AlixPartners, said the consulting firm expects U.S. auto sales to be nearly flat next year, near 15 million units. We don't think the fundamentals will change that dramatically, he said.

That could upset even cautious industry plans -- just as forecasts for a steep drop in 2008 sales were initially dismissed by most executives as too bearish.

By some measures, the pressure may be greatest on Chrysler, now owned by private equity firm Cerberus Capital Management CBS.UL. Private equity invested a record $18.6 billion in the auto industry in 2007, when company valuations were higher and debt costs were lower, according to AlixPartners.

The result: They need to see improvements that are even greater than the rest of the industry, Hoffecker said.

In the meantime, Detroit could still catch a break from moderating fuel prices and for commodities like steel that have driven the average vehicle cost up by some $900 this year.

From 2010, the Detroit automakers will start to see bigger savings from a cost-cutting U.S. labor contract as health care costs shift to a trust fund aligned with the United Auto Workers union and off their books.

All this boils down to can they survive the next 18 months to 24 months, said Robert Streda, an analyst with credit rating agency DBRS. I think they have enough liquidity to get through, unless the U.S. market falls down a lot farther than it already has, and I would see that as being unlikely.

The cost of protecting Ford and GM debt through credit default swaps spiked in March and has remained higher than late 2007 levels since.

The Chicago Board Options Exchange has a parallel option contract on Ford and GM. The contracts, which remain lightly traded, would pay out if either automaker filed for bankruptcy or defaulted on payments before September 2012.

Indicative prices point to a roughly 48 percent default risk for Ford and a 47 percent risk for GM over that period.