How Much of Your Money Are These Automakers Wasting?

In order to fill demand when customers make a purchase, most companies prepare their products ahead of time. This is inventory – and sometimes companies prepare too much. The number of cars an automaker chooses to produce in advance, which then sit and wait to be bought, has a big effect on you, the investor.

Inventory affects a company's bottom line, making it a very important item for investors to dig in to. Understanding types and levels of inventory will make you a more informed investor, allowing you to allocate your money to efficient and profitable companies.

Types of inventory
When a company buys materials to make its products, this is called "raw materials" inventory. For example, all of the steel and plastic sitting in Ford (NYSE: F  ) factories, waiting to be molded into a car door, are raw materials.

After a company begins working with its raw materials but before the product is ready for sale, the "thing" (it's not really just steel and plastic anymore, but they might not be ready to call it a car just yet) is called "work-in-progress" inventory. For example, General Motors (NYSE: GM  ) might spend 18 hours to build a car, and during this period the cost of all the accompanying parts make up its work-in-progress inventory.

Lastly, the "finished goods" inventory is made up of items ready for distribution and sale. All of the completed cars that Tesla Motors (NASDAQ: TSLA  ) hasn't made money on yet are finished goods.

Together, these three types of inventories create the overall, general "inventory" category on a company's balance sheet.

Below is a breakdown of the three types of inventory for a single automaker. As you can see, most inventory is in the finished goods stage, and only a small portion are in the work-in-progress stage.

NSANY Raw Materials Inventory (Annual) Chart

NSANY Inventory (Annual) data by YCharts

The costs of inventory
There are costs associated with holding inventory, whether as raw materials, work-in-progress, or finished goods.

Consider the insurance that Nissan (NASDAQOTH: NSANY  ) pays to secure its warehouse of cars (after all, what if there is a theft or fire?). Additionally, it risks one of its models going out of style after paying to have it built, but before selling it. Automakers also pay handsomely for the costs of owning and maintaining storage space, as well as handling, tracking, and maintaining inventories.

As investors, we'd rather have the company put its wealth (and our wealth) to more productive uses than holding too much inventory.

Levels of inventory
I have written before about the importance of supply chain efficiency for automakers. Basically, materials are relatively expensive in the auto industry. Because of this, our investigation of inventory levels is very relevant for auto investors. Comparing the levels of inventory that several major automakers hold is a good place to start.

If we were to look at balance sheets for each of the four automakers mentioned above, we'd see that GM holds about double the inventory of Ford, Nissan is somewhere in between GM and Ford, and Tesla holds less than 5% of the inventory as the other three.

If everything else about these companies were the same, this comparison would be enough to conclude that Tesla has what we call a "leaner" and better inventory system (trimming the "fat," they hold less unsold inventory.)

Because these companies are all different sizes though, it is not enough to look at the level of inventory. Below, I divide level of inventory for the most recent year by the companies' assets. This gives an idea of how much inventory each company holds relative to its size.

Inventory-to-Size Comparison, FY 2012
  Company    Inventory ($millions)    Assets* ($millions)    Inventory/Assets 
Ford 7,362 86,458 8.52%
GM 14,714 136,775 10.76%
Nissan 1,125,121** 8,630,134** 13.04%
Tesla 269 1,114 24.10%

*Assets exclude assets associated with financing operations. **Nissan figures reported in Japanese Yen

Here Ford and GM shine – both clearly run an efficient inventory system. Because these two automakers aren't using as much money to hold high levels of inventory, they instead can put investors' wealth to more productive uses – perhaps investing in advertising or R&D.

I think Ford is a great investment. The comparative efficiency of its inventory system adds to that feeling, and also makes me want to look into GM more – its inventory ratio is very good, too. I'm also making a mental note that, given these figures, if I ever see an established global auto giant with an inventory-to-asset ratio over 20% or so, I'm going to be wary of its management's use of capital. For Tesla, since its sales are still relatively low, it is not yet clear what its appropriate level of inventory should be.

The flip side
Of course, we wouldn't like a company with zero inventory. If Nissan didn't buy its raw materials and build until a Pathfinder was ordered, then a customer would be lucky to get a vehicle in two years. In order to have fast order-to-delivery time, companies have to hold a significant minimum level of inventory.

If any of these higher-unit car companies decided to slash their levels of inventory to, say half a billion dollars, I'd be worried that they couldn't make timely deliveries to their customers and would lose sales as a result. I haven't heard such a complaint at their current levels, however, and so I don't think there is a problem of too little inventory here.

More research to do
Inventory is a single line on the balance sheet, and should not make or break any investment. As our goal is to incorporate relevant information into the best investment decisions we can make, though, looking at levels of inventory can help us achieve that goal.

In addition to considering relative levels of inventory, keep an eye on changes in inventory systems in the future. If a company improves the efficiency of its inventory system or its CEO emphasizes its focus on efficient inventories, this can be a good sign of innovative and forward-thinking management.

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Read/Post Comments (4) | Recommend This Article (1)

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  • Report this Comment On April 01, 2014, at 9:03 AM, Foolaloof wrote:

    Brian, thanks for your analysis.

    As a close follower of Tesla both as a vehicle owner and as an investor, I confess to confusion about your reference to Tesla's "LESS unsold inventory".

    Every car made by Tesla was sold prior to assembly according to the specifications of the purchaser. That is, each car is made to order post-deposit, and delivered when production is complete. The only lag from completion to delivery is transporting the cars around the world to attempt to satisfy the worldwide demand that Tesla has no hope of meeting in the imminent future. No such issues arise for the other auto manufacturers you reference. They would be more attractive if, like Tesla, they could not keep up with exploding demand .

    And so I must disagree with your observation that we wouldn't want a company with no inventory. I will align myself with those who would rather see every vehicle sold before it's built - your highlighted recommendation of another manufacturer as an investment notwithstanding.

    Yours in Fooldom,

    Foolaloof

  • Report this Comment On April 02, 2014, at 8:32 AM, davidthal wrote:

    I'm a little skeptical of these figures. Do the auto manufacturer inventory figures include the unsold inventory held by their dealers? If not, then the figures disguise the actual amount of inventory by shifting the actual "inventory" of unsold vehicles to dealers that have not paid for them yet (accounts receivable to the auto manufacturer).

    Tesla, on the other hand, has no such inventory "shifting" situation at all since there are no dealers to take the vehicles from the manufacturer.

  • Report this Comment On April 02, 2014, at 8:44 AM, davidthal wrote:

    One problem with the major auto manufacturers is that they want to sell the inventory they have produced rather than sell you the customized vehicle that you actually want. I don't think I have ever bought a vehicle with the exact options I wanted and had to overpay for stuff I didn't need or want simply because no dealer had one in inventory that met my requirements.

    The ability to order a vehicle with the options you want is another major change in the auto marketplace that will be attractive to many buyers. I suspect that buyers can expect some meaningful cost savings from buying a vehicle to meet one's custom specifications instead of having to accept what a dealer has in inventory. I buy computers online so that I can choose the options I want and would gladly do so when buying a car. Not everyone has to have a car the instant they want one.

    If Tesla feels the need to attract those buyers who just have to have a car now, they could establish a loaner program like they plan to do for people who need service. New buyers could pay a premium to "lease" a loaner vehicle until their car has been produced. This, of course, is a form of inventory, but if it generates revenue it is not idle inventory.

  • Report this Comment On April 02, 2014, at 10:38 AM, damilkman wrote:

    I think overlooked is the market segment. When you sell luxury cars the customer is willing to pay a premium for exactly what they want. We observe this in that Tesla is selling a 70K car for on average 100K.

    Fast forward to the regular car market. Unlike the filthy rich who buy Tesla's price does matter. We will purchase a car that is not idea if the price and incentives are right.

    We observe the same behavior in other market segments. Rich people will pay a premium to have their house built, designed, and furnished exactly to what they want. They will purchase the exact attire that they want and if they want a toy, they will get it.

    Everyone else acquires the house that fits the budget even if it does not have exactly what they want. We may furnish with something that does not exactly fit because COSTCO has a great deal, and we might buy those shoes on sale at the outlet mall for 30 bucks even if the 150 dollar pair has everything we want.

    People seem to think that everything Tesla is doing in the luxury car market can be translated to consumer. If you do not believe me if you could order exactly the car you wanted, how much more would you be willing to pay to have exactly what you wanted? Most of us would probably balk if that number was 2500 dollars much less 30000.

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