Led by the U.S. decline in automotive sales, economic precitor Fitch Ratings anticipates that 2003 will be one of the most important years in recent North American automotive history. Fitch anticipates that domestic automakers will continue to focus much of their efforts on maintaining their currently strong levels of liquidity by continued cost cutting efforts and by focusing on free cash generation from their operating businesses. On the sales front, Fitch anticipates that North American light vehicle sales volumes will be down 4-7% led principally by the U.S. market, which is forecasted to be between 15.5 and 16.0 million units. It is anticipated that this decrease in volumes represents a move towards what would be considered normalized levels of demand rather than a ‘payback’ for relatively high levels of incentive spending (although it is clear that incentives have propped-up demand through the relatively weak post-bubble economy). Fitch estimates that this U.S. normalized demand level is approximately 15.5 million units. This replacement demand hypothesis is based upon historical industry sales levels that averaged 15.9 million units since the end of the early 1990s recession. Also of note is the fact that since 1991 (which includes the 1990s recession), U.S. light vehicles sales have averaged 15.1 million units. (Although some might argue that the past (i.e. the 1990s automotive boom) is not necessarily reflective of future, it is also clearly short-sighted to overlook existing favorable demographics in areas such as immigration, wealth creation, and household formation rates. These factors are the principal reasons behind the estimated up tick in replacement demand over the last ten years.) I would suggest writing something like ‘It is important to reflect on past data as existing favorable demographics in areas such as immigration, wealth creation, and household formation rates are as these are the principal reasons behind the estimated up tick in replacement demand over the last ten years.’ Another industry trend that bears watching is net pricing, which is defined as the change in the year-over-year vehicle price (of a comparably equipped vehicle) net of vehicle incentives. Negative net pricing, which has existed for the Big Three for much of the last six years, has definitely played a role in recent high levels of light vehicle sales. The most obvious impact is that customers see this longer-term negative net pricing trend in the form of today’s relatively high levels of vehicle affordability. Although negative net pricing was taken to another level in the last recession (2001) and with post September 11 marketing efforts, it is clear that these trends can not continue forever as automakers (and their suppliers) can only cut costs for so long. Automakers, especially the domestic U.S. companies, will have to begin to alter this trend via capacity rationalization, continued cost cutting, and through new successful product launches. This effort will have to be led by GM as it is clearly the lead er in this trend of negative net pricing. The upcoming 2003 UAW contract negotiation will be one of the most important in the last two decades. Pressured by years of relentless competition, the Big Three have done much to rationalize their non-union cost structure. Given the competitive nature of the industry, the Big Three have to cut costs in previously untouched areas. As a result, the Big Three will have to work in conjunction with the union to resolve complex issues ranging from required capacity reductions (Fitch estimates that the Big Three need to remove over 2.5 million units of capacity) to benefit costs (current hourly benefit plans are unsustainable given projected levels of pension/healthcare cost increases and the prevailing legacy issue). When it is all said and done, the next contract must provide the opportunity to achieve an improved cost structure and improved operating flexibility. Anything less will impair long-term cost competitiveness. On the pension front, 2003 will be an important year for the Big Three. With historically low interest rates, a weak economy, and three years of negative market returns, the pension issue has seen its ‘perfect’ storm. At the macro level, Fitch anticipates that most companies will reduce their expected rate of return to 8-9% and that all companies will reduce their discount rate 25-50 bps. These decreases will have no impact on future cash funding requirements, which are governed by ERISA and not FAS 87 accounting. That being said, the pension issue represents a significant continuing claim on cash flows, limiting funds available to re-invest or return to shareholders. How companies manage through this process will be an important factor in evaluating overall company performance. Although there will be a significant number of important new product launches in 2003, the most important launch will be Ford’s updated F-Series. The foundation upon which Ford’s current business is built, the F-Series is Ford’s most important product line with YTD sales of over 680,000 units. The F-Series is not only the source of significant volume (over 20% of light vehicle sales), but is also the most significant contributor to Ford’s variable profit. As such, Ford simply must get the launch right and can ill afford a repeat of recent launch failures such as those with the Ford Explorer and the Ford Escape. Other important launches include the updated Ford Windstar, the updated Ford Escape, the Jaguar XJ (delayed from 2002), and several updated Volvo products (S40/V40/S80). Important product launches from the other domestic automakers include numerous General Motors entries such as the Epsilon-based Pontiac Grand Prix / Chevy Malibu, new Cadillac products including the XLR (luxury roadster) and the Cadillac Escalade ESV (similar in size to the Chevy Suburban), the new Chevy SSR (hot-rod pickup), the new GMC Envoy XUV (perhaps the world’s most flexible SUV), and the new mid-size pickup called the Chevy Colorado. Important DaimlerChrysler (DCX) launches include the all new Chrysler Crossfire (sports coupe), the all new Chrysler Pacifica (station wagon/SUV), an updated Dodge Dakota (mid-size pickup), an updated Dodge Durango (mid-size SUV), and the Dodge Sprinter (a commercial van brought over from Europe). Although competition will intensify in 2003 as foreign competitors introduce a host of new/updated entries across most segments (often by adding additional domestic capacity), the product segment of greatest concern to the truck dominated domestic automakers is the upcoming Nissan full-size platform. Enjoying success with its new product renaissance led by the Motor Trend Car of the Year winner the Infiniti G35, Nissan is the next new entrant into this very profitable full-size segment. Should Nissan enjoy substantial success in this area then it could potentially encourage additional entries from the likes of Dodge (SUV) and Honda.