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Auto Recovery in Progress but Still a Long Way to Go

Jeremy Glaser

Jeremy Glaser: For, I'm Jeremy Glaser. With the North American International Auto Show getting ready to kickoff in Detroit, I thought it would be a good time to sit down with Senior Equity Analyst, Dave Whiston and Senior Credit Analyst Rick Tauber to see the state of the automotive industry and how their balance sheets are fairing?

Gentlemen, thanks so much for joining me today.

Dave Whiston: Thanks.

Rick Tauber: Thank you.

Glaser: So, Dave, could we just take the big picture view of the auto industry? How did sales look towards the end of 2010 and what's your view of sales going forward in this next year?

Whiston: Well, for a long time now I've been very optimistic about the recovery in U.S. autos and the December sales, U.S. new light-vehicle sales that came out recently confirm that. December is actually the best month of the year. We had a seasonally adjusted annualized selling rate or SAAR jumping all the way up to 12.6 million and that's a great sign.

We still have a long way to go though. Just to me, replacement demand for example, you need to get to about 13.2 million, 13.5 million. So, we're still below replacement demand which tells you there is still a long way to go for a recovery. Normalized levels are probably between 16 million, over 17 million, but I'm very optimistic about the fact that the worst is over. For 2010, we were at 11.6 million versus 10.4 million in 2009, so the recovery has already started but there's a ways to go.

Glaser: Would you expect that 2011 would see a sharp jump up or you expect some more gradual ramp up to that real replacement level?

Whiston: The cadence of that recovery is, what every – you know whether you're an analyst or an auto executive, everyone is trying to figure that out and I'm looking for 13 million in 2011. I have seen some other numbers as low as 12.5 million which is obviously still up from the 2010 levels, but I've also seen numbers as high as 14 and 15 million. So, I think everyone agrees we are going up, it's just a matter of how steep is that slope.

Glaser: So, what manufacturers are in the best positions to take advantage of this increase in sales?

Whiston: Well, I think it benefits everybody because ultimately auto manufacturing is a volume game. For investors, I'm looking for more of our cheaper 4-star stocks. We don't have any 5-stars right now in the OEM space, but GM, Ford, Toyota and Daimler are my personal favorites.

Glaser: Are there any companies that you think aren't tooled to compete right now, maybe don't have the products out there or don't have the consumer awareness of their new products?

Whiston: Not really. With the major restructurings and bankruptcies we had, the weak players all went into Chapter 11 and reorganized and some of the really weak suppliers just flat out liquidated. Obviously, GM and Chrysler's bankruptcies are well documented, but whether you agreed with those bailouts or not they're done, it's over with, it's time to move on and the future for GM in particular of those two looks really bright.

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Glaser: One of the trends we've seen certainly in terms of announcements is to electric cars, to plug-in hybrid cars are being highly promoted. Are these sorts of products actually going to move the need in terms of sales; are they more promotional kind of PR stunts than actual products?

Whiston: I'm rather cynical about electric vehicles I think they're more of what in the industry called Halo car, for example the Toyota Prius has done wonders for consumers thinking of Toyota as a dream company, but in reality hybrids for example, all they make up a little over 2% of all of U.S. new light vehicle sales, which isn't that much. People tend to forget that Toyota, still relies on making full-size pickups like the Tundra and SUVs and crossovers, it's just like Detroit, they just sell more cars and light trucks, Toyota, Honda do when compared to GM, Ford and Chrysler.

Glaser: Rick, with this pending recovery in auto sales and the continuing recovery not our sales, how are the balance sheets, it sounds that credit quality of the major auto suppliers.

Rick: With the continued recovery in auto sales, how have the balance sheets and the credit quality of the major manufacturers stacked up?

Tauber: We've seen a nice change in recovery of the more distressed type companies in particular and of course Ford comes to mind, but I think the interesting thing is, if you're focused on the domestic auto space as a bond investor for example for the last five years its looked pretty dismal as Dave mentioned, Ford and, I mean GM and Chrysler went through bankruptcy and number of suppliers have and Ford narrowly escaped.

If you look globally, which includes our coverage list you've seen a lot of companies with strong investment grade rating, so there is really – it's not been an industry problem per se, it's been more individual problems. Certainly the recovery is going to help, I think as Dave highlighted all companies, but I think even more so the ones that are kind of coming out of more distress type situations.

Glaser: How do our credit ratings for the sector differ, if maybe there are some of the other rating agencies?

Tauber: Sure, I'd highlight that of the nine names that we cover, the auto OEMs, eight are foreign companies, Ford being the other one. At the top end we've got Toyota and Honda both at strong A ratings at Morningstar although Toyota also garnishes AA ratings at a couple of the NRSROs who are a little bit less favorable on that name.

Ford as I mentioned, we recently upgraded to investment grade at BBB minus from our initial rating of BB back in May. Rating agencies are still on the kind of the mid BB category or worse. So, we are a few notches higher on Ford and then one other outlier is Peugeot actually which is a little bit more of a niche player I think in France which we have a weak BB. That's our lowest rated manufacturer right now. They have an investment grade rating at one of the rating agencies. We don't rate GM since they don't have any public bonds outstanding, so that should be noted.

Glaser: You mentioned that we upgraded Ford to investment grade recently. Can you give us a little bit more color as to why you think that Ford credit has improved so much in the past year?

Tauber: Sure. Clearly they've made great efforts to restructure their balance sheet. They've paid down quite a bit of debt. That's been their real focus and that's certainly in part why we've upgraded them to BBB minus.

We think going forward they are going to generate substantial free cash flow along the lines of probably greater than $6 billion a year going forward as they continued to generate – I mean they are targeting investment grade ratings at the NRSROs which is still a little bit a ways away based on where they are rated today. So, we think their credit quality continues to improve as they really focus on improving the balance sheet, which should be reasonably easy for them to do if our auto forecast proves accurate.

Glaser: That's wonderful. Rick, Dave, thanks so much for speaking with me today.

Whiston: Thanks.

Tauber: Thank you.

Glaser: For, I am Jeremy Glaser.