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Carmakers Face Rising Debt

Strained Balance Sheets

The automotive industry is accumulating a massive amount of debt, putting pressure on already strained balance sheets. Easy access to capital over the past few years, as a result of a healthy financial system and accommodative monetary policy from the Federal Reserve, allowed auto-giants to borrow cheaply. While the extra cash was nice, it also increased outstanding liabilities and associated interest payments.

This was all before coronavirus. As the pandemic worsened, causing carmakers to shutter plants around the world, sales stalled in big markets like Europe, the US, and China. As a result of coronavirus-related shutdowns, car manufacturers and suppliers raised $21.7 billion in additional long-term debt through June 16. The total industry debt load is now at least $1.1 trillion, raising the leverage multiple from 3.0 times last year to 3.4 times this year.

Servicing this historic amount of debt is something that investors are concerned about, especially as carmakers race to invest in new technologies that could pay off down the road.

Commitment to New Technologies

The pandemic is forcing automakers to rethink how they will pay for programs they have already committed to. For example, car companies and suppliers promised almost $234 billion to projects dedicated to electric vehicles. These initiatives were supposed to begin in 2020 but inevitably some will have to be delayed or cut.

Shutting down these programs could make it hard for certain car brands to stay competitive in the long run, so automakers are forced with difficult choices between saving money now and sacrificing potential business in the future. Electric vehicles are becoming an increasingly important part of the auto industry. Europe continues to tighten its strict emissions standards and Tesla’s (TSLA) brand popularity shows demand for electric vehicles is stronger than ever.

However, with debt piling up and the high cost of batteries still a major issue, automakers are looking for creative fixes. Some, like General Motors (GM) and BMW (BMW), have opted for restructuring programs in an effort to recoup some of the cash being spent on new technologies. Others, like Ford (F) and Volkswagen (VWAPY), have turned to collaborating with one another to find new ways to cut costs.

A Lasting Leverage Problem

Many carmakers are hoping for a “V-shaped recovery” in the auto industry, but analysts continue to remind investors that 2020 isn’t like the Great Recession of 2009.

During the last recession, carmakers were given a somewhat of a fresh start after bankruptcy and government bailouts. This time around, analysts warn that car companies will have leverage issues long after the pandemic has ended, even if sales bounce back. Over a trillion dollars in debt is a lot to race back from, and some investors think this could put the breaks on the auto industry heading into next year.

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