Sometimes being an investor is a scary thing – an event could take place at any time that could hurt the profitability of your investment. I'm long Ford (NYSE: F ) and General Motors (NYSE: GM ) so I've been keeping a close eye on the Trans-Pacific Partnership trade negotiations that could have drastic effects on their profits – while benefiting Toyota (NYSE: TM ) and Honda (NYSE: HMC ) . I'll break it down and show you how it could negatively affect Detroit automaker revenues by over $1.3 billion dollars – and why I'll still keep my positions in Ford and GM.
During the trade talks the U.S. government agreed to gradually abolish all tariffs in place on Japanese vehicles entering the nation. Removing the tariffs will aid the Japanese while doing nothing to help Detroit's comeback. Japanese vehicles previously had a 2.5% tariff on cars brought in, and 25% on trucks. In an industry with margins often in the single digits, 2.5% is a huge difference – and 25% is drastic.
Detroit cries foul
As you can imagine, Detroit is none too happy with this development. Ford, GM and Chrysler are using their voices, lobbyists, and any possible leverage to ask the government to reconsider. Just as they had begun to repair the awful image resulting from years of terrible management and awful vehicles, this hurdle could slow financial progress. I admit, there are a lot of variables to take into account, but let's break it down in a simple manner and see what effect removing these tariffs would have.
A study released by the Center for Automotive Research said that erasing the 2.5% tariff on cars would cause the Japanese to increase their vehicle exports to the U.S. by over 100,000 units. On the other hand of the equation, a study partially underwritten by Ford, showed that Detroit vehicle production would fall by about 65,000 units. To put that in perspective, that's slightly less than sales of Ford's popular Escape for the first quarter. The study claims that the decline in production would cause 2,600 American factory jobs to be lost. After a trickle-down effect it would cause lost jobs for Detroit's auto suppliers to reach as much as 9,000 – not good.
To get us an idea of what this could do to Detroit automakers bottom lines, let's roughly estimate what a loss of 65,000 in vehicle sales could look like. Let's say 65,000 of Ford's popular Fusion sales disappeared due to the tariff removal. At a manufacturer's suggested retail price of $21,900, let's knock off a couple thousand for the difference between wholesale and dealer prices. That totals up to about $1.3 billion in top line revenues. Now if we take into account Ford's margin per vehicle – for simplicity's sake we'll say 8% – that would represent a net income loss slightly over $100 million dollars. That number isn't earth-shattering, but it's not chump change, either. Ford and GM would both love to have that amount taken off their respective Europe losses this next conference call. You also have to keep in mind the 25% drop in the truck tariffs could have a much larger impact in the bottom-line figure.
All is not lost
While this is definitely a topic of interest to Ford and GM investors, don't let the big headlines – like this one – scare you away. The tariffs won't just be chopped off immediately, rather they will be gradually declined "over the longest possible period of time". While I can't guess the timeline they'll negotiate, it looks to be far enough into the future that this won't have as big an impact as Detroit is crying foul about. As investors we should be glad that Detroit is screaming and over-exaggerating because that shows management doing its best to use its leverage. We should be more worried if trade negotiations like this take place and Detroit is silent.
In addition to that, the impact won't be felt by just one automaker, as in my example, but spread between all automakers. Just because the tariff removal will benefit the Japanese, it doesn't guarantee that their vehicles will sell any better. If Ford and GM's recent successes in quality and popularity of vehicles continues, investors have nothing to worry about.
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