Major League Debtors The Rude Awakening Wall Street, New York Friday, February 11, 2005 ------------------------- The Rude Awakening PRESENTS: AAA baseball teams…packed
full of promising youngsters and former big leaguers.
Today, we pick on the latter: Once they were stars; now
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By Eric J. Fry The ranks of BBB- credits are a lot like AAA baseball
teams. Both groups include "players" that aren't quite Big League
material - either because their talents are diminishing or
because their talents aren't yet fully developed…or
perhaps, because they never really possessed much talent in
the first place. In other words, the ranks of BBB- credits and AAA ball
clubs contain both "has-beens" and "up-and-comers." In the AAA, for example, 30-something former big leaguers
play side-by-side with 20-something prospects. BBB- credits
include an equally diverse - if not motley - collection of
players. Thus, we find in the ranks of BBB- credits the
curious juxtaposition of General Motors and the Russian
Government. These two borrowers may be BBB- "teammates,"
but we doubt they'll be on the same team for long. General Motors, the has-been of our metaphor, once boasted
a formidable AAA credit rating, just like the U.S. Treasury
itself. Throughout the 1970s, while GM was busily responding to the
Arab oil embargo by churning out yacht-sized Cadillac
Fleetwoods, the automaker was able to borrow money at
preferred AAA rates. In 1981, however, the company's
downward slide "officially" began, as S&P dropped GM's
rating to AA+. Today, the beleaguered American icon's debt rating sits
just one downgrade away from "junk" status. By contrast, the Russian government had never managed to
earn an investment-grade rating…until a few weeks ago. Like a career minor leaguer, the Russian government's
credit rating bounced around in the junk ranks for several
years. Then, in 1998, this troubled borrower validated its
lowly rating by defaulting on its sovereign foreign debts.
(Hence the "SD" rating, displayed in the chart below). 
This ignominious event - otherwise known as the "Russian
debt crisis" - marked the nadir of Russia's post-communist
economic odyssey. But it has been recovering steadily ever
since. Aided by a doubling of the oil price, the Russian
economy has clawed its way back to international
respectability, finally garnering an "investment grade"
rating from S&P late last month. But what lies ahead for Russia and General Motors? Which of
these two marginal credits will advance to the big leagues
and which will fall even deeper into the minors? To formulate a guess, we'll need to take a brief look at
their respective stat sheets. This morning, we'll go under
the hood of the General Motors Corporation. Then on
Tuesday, next week, we'll turn the spotlight on the
Russians… GM's debt load is massive and growing. Its net debt
outstanding has doubled over the last four years to $244
billion. In addition, GM's balance sheet contains a
towering pension liability of $102.4 billion and a $67.5
billion liability for other post-employment benefits
(OPEB), primarily health care, insurance and other benefits
that the company is committed to providing both current
retires and active employees. These already-considerable
costs seem certain to grow. "In 2003," the Wall Street Journal reports, "GM assumed in
its accounting that initial health-care costs would
increase by 8.5% this year, and had estimated that that
growth rate would gradually decline to about 5% over a six-
year time frame. But GM said actual healthcare inflation is
running in the low double digits." GM ruefully admits that
every 1% increase in healthcare costs increases its
liability by $7.6 billion - a not-inconsiderable number for
a company that earned only $3.8 billion over the last 12
months. Unfortunately, a peak inside GM's recent financial results
provides no comfort whatsoever to bondholders. Over the
last two years, the automaker has earned very little money
selling autos. Instead, the company's finance unit, GMAC,
has produced three quarters of the entire company's net
income. And in the final quarter of last year, the finance
unit produced ALL the net income. Equally disconcerting is
the fact that GMAC's mortgage division has produced more
net income over the last two years than all of GM's
worldwide auto operations. These facts are not so surprising when one considers that
GM's North American market share eroded last year from
27.4% to 26.7%, despite the fact that GM spends more than
$4,000 per vehicle to "incentivize" buyers to drive one of
its cars off the lot. Net-net, GM seems fully deserving of its "near junk" rating
and seems likely to trend from bad to worse. In theory, the automaker could recapture a sliver of its
past glory by regaining market share from the likes of
Toyota Motors; or it could begin designing such winning
vehicles that it can reduce the size of the "buyer
incentives" it currently pays; or the company might manage
to reduce its pension plan liability by consistently
boosting its annual investment returns above the 14% it
earned last year, while also restraining the growth rate of
its health care expenses. If so, the automaker were financial condition would
certainly improve. If not, GM may increasingly become a
kind of health care company that makes cars on the side.
The adverse trends plaguing GM might simply continue, in
which case this BBB- borrower could slip into a kind of
junk-credit abyss - paying ever higher interest rates,
while struggling to satisfy ever-growing liabilities. Eastman Kodak, another former American powerhouse, tumbled
into the junk bond ranks last month. Some player simply
don't belong in the big leagues…General Motors may be one
of them. Russia might be another…we will find out on
Tuesday morning…] [Editor's Note: Steve Sarnoff loves trading GM stock. We
went back and checked his trading record for this
particular stock and this is what we found: 4 trades, all
four were winners. The worst gain was 49% in 2003 and the
best, 1,201% in August 2001, buying puts just days before
the 9/11 attacks. Steve's track record is always impressive, no matter how
you scrutinize it… Options Hotline
http://www.agora-inc.com/reports/OHL/WOHLF113 --- Advertisement --- Important News for U.S. Stockholders, Bondholders and
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itself out. But hurry… there isn't very much time left. http://www.agora-inc.com/reports/RCH/WRCHF202 ------------------------- Did You Notice…?
By Eric J. Fry Please permit your New York editor to be the first to
congratulate his Baltimore-based counterpart for
anticipating the bond market's recent mini-rally. Mr. Dyson's well-timed observations would have enabled a
nimble bond trader to sidestep a "harrowing" 7-basis point
jump in interest rates between January 21 and today. Trusting his contrary instincts late last month, Mr. Dyson
remarked, "We suddenly think yields are going lower and
only because everyone thinks they're not." So far, so good.
The 10-year yield has, in fact, dipped from 4.16% to 4.09%. But this short-term rally (in price, and drop in yield) is
not necessarily indicative of future trends. As your New
York editor observed in the January 21 edition of the Rude
Awakening, "Bonds may continue rallying a bit, just as the
dollar may continue rallying a bit, but we would be
hesitant to abandon the short side of either one of these
markets for the sake of trying to capture a short-term,
counter-trend move." Sometimes an investor can become too contrarian for his own
good," we cautioned, "Buying a 10-year Treasury note
yielding 4.16% may be one of those times." In yesterday's column, Mr. Dyson expressed a similar
sentiment. While not completely abandoning his contrary
instincts, Mr. Dyson nevertheless advised, "Whatever it is
that makes bond prices rise, we're reluctant to bet on it,
just for the sake of trying to capture a short-term,
counter-trend move…The best action, in this case, is
probably inaction." Your New York editor applauds this newfound agnosticism. [Editor's Note: Chris Mayer bats on the same team as Eric.
He thinks rates have been artificially suppressed and are
set to rise imminently. His stock portfolio reflects
this…companies with fixed assets that sweat. Inflation
actually helps these companies… The Fleet Street Letter
http://www.agora-inc.com/reports/FST/WFSTEC24 ---------------- And The Markets… | Thursday | Wednesday | This week | Year-to-Date | DOW | 10,750 | 10,664 | 33 | -0.3% | S&P | 1,197 | 1,192 | -6 | -1.2% | NASDAQ | 2,053 | 2,053 | -34 | -5.6% | 10-year Treasury | 4.08% | 3.98% | 0.00 | -0.14 | 30-year Treasury | 4.47% | 4.37% | -0.01 | -0.35 | Russell 2000 | 627 | 626 | -11 | -3.8% | Gold | $418.00 | $413.50 | $3.20 | -4.5% | Silver | $6.95 | $6.60 | $0.28 | 2.0% | CRB | 285.27 | 280.86 | 4.01 | 0.5% | WTI NYMEX CRUDE | $47.10 | $45.46 | $0.62 | 8.4% | Yen (YEN/USD) | JPY 105.85 | JPY 105.66 | -1.79 | -3.2% | Dollar (USD/EUR) | $1.2876 | $1.2806 | -2 | 5.0% | Dollar (USD/GBP) | $1.8688 | $1.8591 | 69 | 2.6% |
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