As the Auto Industry's Resurgence Continues, Will Unions Hold Detroit's Big Three Back?

Here is one risk that investors in the iconic American automakers should keep an eye on.

Jan 10, 2014 at 6:01PM

I've been bullish on the automotive industry for years. I own stock in both Ford and General Motors, and I see great potential in their businesses as the companies continue to put distance between their current states of affairs and the great recession that brought the industry to its knees. But there's one big risk I'll be keeping an eye on next year. Let's take a look where the auto industry currently is, how profit sharing affects earnings figures, and how things could change as soon as 2015.

Outstanding 2013
In an industry where a fraction of market share is vital, any change is huge. Consider that all three Detroit automakers -- Ford (NYSE:F), General Motors (NYSE:GM), and Chrysler -- gained annual market share in the same year only once in the last two and a half decades. Though there is a caveat for that stat because the 2011 tsunami put Japanese automakers in a bind.

But as the three domestic automakers entered December 2013, they were on pace to accomplish that feat legitimately. While GM ended up flat for the year, Ford gained far more than any other major automaker.

Market
Graph by author. Source: The Wall Street Journal

The effect of domestic autos gaining market share is compounded, and the average for annual vehicle sales continues to rise in the U.S.

Long
Graph by author. Source: Automotive News DataCenter

But as the automotive resurgence continues, and the industry becomes more profitable, will increased profit sharing and bonuses make automakers less attractive investments? How exactly does profit sharing affect investors? Let's take a look.

Profit sharing
Detroit's Big Three will announce final figures next month, but industry analysts expect the companies to send checks out to 130,000 workers that will total more than $800 million in profit sharing, according to The Detroit News

Profit sharing at Ford and General Motors is based on profits from its main driver -- the North American market. On average workers receive about $1 for every $1 million in North American pretax profit. Based off Ford's forecast of $8.5 billion in pretax profits, mostly from North America, that would equal a profit sharing of roughly $400 million. While profit sharing is certainly a chunk of change investors would prefer to have in the pretax earnings figure -- which would boost Ford's pretax earnings to nearly $9 billion -- that's just how the industry works for Detroit's automakers, at least for now.

Profit sharing is also a cost investors can't directly keep track of quarterly because it's wrapped into Ford's automotive cost of sales or its selling, administrative, and other expenses. You have to wait until the automakers release the full figure annually, or estimate using the rule of thumb above.

But, Ford's profit-sharing amounts are accrued throughout the year, with adjustments made quarterly if needed. It's helpful for investors to know there won't ever be any lump-sum expenses as some might expect to happen in the fourth quarter when full-year profits are finalized.

That's how profit sharing works currently, but things could change drastically for these automakers next year -- and profits will be affected directly. 

2015 contract
Here are two things to keep in mind going forward. Investors can breathe a small sigh of relief as a profit-sharing ceiling and floor exist. The profit sharing is capped at $12,000 per employee -- using estimates from above, Ford will likely pay around $8,500 per employee for 2013. On the opposite end, the profit sharing is axed if automakers don't make at least $1.25 billion in profit.  

A second thing to watch is approaching quickly. In 2011 Ford and General Motors reached an agreement with its United Auto Workers for a four-year agreement. Three years ago jobs were the most important factor, and neither side felt like the economy or industry was strong enough to ask the other for large concessions. That, however, could change after the last few years have brought more prosperity to Detroit's automakers, and you can bet the union will want its fair share of the pie when negotiations heat up next year. That could mean a push for more profit sharing, bigger bonuses, better pension perks, or a multitude of other things that would come at a much larger cost to Ford and General Motors.

One of the biggest developments for Ford last year was cutting its underfunded pension status by nearly half, from $18.7 billion in 2012 to roughly $10 billion last year. If the automakers concede on pension or profit-sharing topics to avoid potential production disruptions, it could be a blow to profitability for investors. 

Bottom line
Right now profit sharing isn't holding Ford or General Motors back, though it is likely to drastically change one way or another in 2015. Ford and GM will likely begin negotiations with the United Auto Workers in September 2015, and if the union takes a harder negotiating stance it could get ugly. That said, keep in mind Boeing recently put another nail in the coffin for pension-style retirements when it leveraged its well-paid production jobs and the Machinists union reluctantly agreed to switch from a pension-style retirement plan to a defined-benefit contribution plan, like a 401(k). It's all about the leverage; we'll see which side has more come next year. Investors would be wise to watch the situation unfold.

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Fool contributor Daniel Miller owns shares of Ford and General Motors. The Motley Fool recommends Ford and General Motors. The Motley Fool owns shares of Ford. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.

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