September 14, 2023

Why Top Auto Companies Struggle with Debt Challenges?

 You are likely familiar with various car companies' brands, such as Volkswagen, Toyota, BMW, etc. unless you have been living under a rock for the past few decades. The Japanese giant Toyota is the most prominent of these well-known companies, producing the largest number of vehicles worldwide. However, this list does not highlight the most valuable car companies. Instead, it reveals the companies that have paid the most debt globally. It is not uncommon for businesses to acquire debts to function, so being in debt is not necessarily a significant issue for these companies.

Debt Challenges | Tesla | Volkswagen | TATA |

If you look closely at the list, you'll notice a peculiar trend. Out of the 12 companies listed, 6 of them are automotive companies, with Toyota being the company that has acquired the most debt at $186 billion. It's strange to see this trend persist not just in the current year, but in the past as well. In 2019, the most indebted companies also included automotive companies like VW AG, Daimler, Ford Motor Company, and BMW. Upon analyzing data from the past five years, I found that aside from major players in the automobile industry, no other industry had acquired such a large amount of debt. While telecom companies do acquire high amounts of debt, this trend is not as consistent as it is with automotive companies.

It appears that the same situation is now occurring with car companies. This raises a significant question: Why is this exception limited to car companies? Additionally, there is concern over whether these companies may face bankruptcy after acquiring such substantial loans. However, there is no need to worry about this colossal debt causing trouble for these companies, as such an outcome is highly unlikely to occur.

What is the reason for car companies to never go into debt?

Keep the thought of going bankrupt aside, Volkswagen and Toyota are highly profitable automotive brands at this point in time almost every car company acquires a particular amount of debt. Whether it is a significant company or a minor one, this is because operating a car company requires a massive amount of capital. This factor alone is not sufficient, to keep these companies in the list of the top 10 most indebted car companies from around lakhs of the automobile companies around the world. The reason behind that is the finance wings in these companies. 

Did you know that big car companies like Ford, Toyota, and Volkswagen have their own finance departments? These departments help the companies' dealers keep their stock and assist consumers in acquiring loans. To do this, car companies receive a large amount of capital from banks at a lower interest rate. They provide this capital to individuals at a slightly higher interest rate than the one at which they acquired it, resulting in a profit. Due to this approach, car companies have acquired billions of dollars in loans. Although the majority of this capital is acquired by their finance departments, there may be more to the story.

How do Indian Car companies bear the debt?

Let's understand this with two Indian car brands. TATA Motors also has a finance wing. It is called TATA Car Finance and they provide loans exclusively for TATA cars, This finance wing comes under TATA Motors. But if we talk about Mahindra and Mahindra the name of their financial wing is Mahindra and Mahindra Financial Services. But this wing does not come under the Mahindra and Mahindra car company and that's why it is listed as a separate entity in the Indian Stock Market. That's why Mahindra and Mahindra Financial Services can also provide loans on different types of vehicles manufactured by Mahindra and Mahindra and even on the vehicles of other brands unlike TATA Car Finance, etc. However, the car companies that had acquired the most amount of debt in the world provide loans exclusively on their cars just like TATA Motors. We could observe one more thing from here and it is that more car companies are present in this list. More is the amount of debt they have acquired, Toyota, Volkswagen, Ford, and Mercedes are the top companies in the world in terms of revenue we can observe here that the debt size is directly proportional to the size of the company. The bigger the brand, the bigger the debt.

Debt is directly proportional to the size of the company because these companies are selling more vehicles. As discussed earlier these car companies have to first acquire a loan from a bank. The more cars they sell, the more amount of debt these companies would acquire, That is the reason the bigger the brand, the more the amount of debt acquired by them from this, we can also understand that increasing debt figures means that these companies are performing well. 

The debt of Ford.

Since they are selling more vehicles that's the amount of debt is increasing and if we especially talk about Ford then they are escaping from going bankrupt only because of their lending firm. Do you want to know how? The sale figures of Ford is continuously declining in its home market and we can also observe internationally that they are stopping their operations in various markets one after the other. They had exited from Japan and India and are also declining in China. That's why the situation of Ford has become so critical in recent years that if they did not have any financial subsidiary. They could have reported bankruptcy according to a report published in the year 2020 The lending firm under Ford is generating 50% of the overall profit generated by Ford. This means the number of vehicles Ford is selling similar is to the profit they are earning through the interest from the loans they are providing to their customers. But usually, it is observed that the finance arm of any company generates only 15-20% of the profit for the company that's why it has been considered. In the case of Ford if they did not have any finance arm they were not capable of spending capital on the R&D of electric vehicles.

Now we understand that this mountainous debt on the car companies. Is not at all like any typical debt some car companies are even performing exceptionally but debt is acquired by almost every car company. Whether they have a financial wing under them or not are all such companies also profitable? No and from where there comes a U-turn in the story of the debt of these car companies. Now do read very carefully what I am going to say If you follow the car industry closely. You might have also noticed that apart from a few countries in the world. The majority of the countries in the world have only one or two car brands India has only two major car companies TATA Motors, and Mahindra and Mahindra. Korea also has only three major car companies Hyundai, Kia, and Ssangyong, While a country like Australia does not have any car brands and countries that had multiple or successful car companies in the past, the majority of those companies have been already sold out.

Why do car brands do not have any ownership of their own?

Let's talk about the United Kingdom Rolls Royce and Mini Cooper are owned by the BMW group. Bentley is owned by the Volkswagen group. Jaguar and Land Rover are owned by TATA Motors and this leaves only one car brand Aston Martin Its condition is so poor that It can file for bankruptcy anytime. Britain is not the only one that has such a condition. The majority of the European and American car companies have experienced this. It is considered that at one time there were around 300-400 car brands in Britain. But today it can be observed that the brands that are left today do not have any ownership of their own. This is not the case in Britain there are only two companies in the US i.e., Ford and Tesla. They have not filed for bankruptcy till now, according to a tweet written by Elon Musk The US had 1000 Auto start-ups at one time. But today all have become non-existent.

Why have so many brands shut down or been sold?

Even though they had a huge brand value. The answer is Debt other than lending departments, car companies require a tremendous amount of capital for their operations and it is considered that the car business is the toughest in the whole world. It is so difficult to operate a car company that developing a rocket and sending it to the moon is easier. Hear it from the owner of a space company car companies require heavy capital to set up their manufacturing plants to acquire the raw material, to manufacture their cars, to provide the salaries, and to ship their products as well. Apart from this, if the companies observe any problem in the whole batch of any car. They have to recall the cars, remove the flaws, and deliver them back to the customers and if I talk about the year 2023 only General Motors had recalled 6.5 Lakhs SUVs Jeep had recalled 2.19 Lakh cars. In the year 2023 alone Honda has recalled 5 Lakh cars.

Regarding the safety belt issues similarly Indian car companies have also done thousands of recalls. Alone in the year 2023, these expenses are highly diminished in front of a tremendous expense. It is also associated with the car companies and it is R&D For launching new models, And to also upgrade the current models, Automotive Brands have to spend a massive amount of capital. If you don't know, R&D stands for Research and Development apart from this, they have to spend huge capital on the R&D of the engines to continuously get stricter emission norms. Apart from this, safety norms are also getting highly strict around the world and that's why automotive companies have to spend a huge amount of capital on the R&D of both active and passive safety features the biggest transition that the world is experiencing at present. That is the world is shifting from IC Engines vehicles to Electric vehicles Car companies have to spend a huge amount of capital on this due to the same reason.

Debt of Tata Motors and Mahindra

TATA Motors and Mahindra Mahindra are the most cash-rich companies in India and come under the top 10 most indebted companies in India. Yes, because these companies also use the majority of the debt in the R&D of cars. You can observe the same in the chart car companies spend huge amounts of capital on the R&D of cars. What is the intensity of the R&D of these car companies? From this chart, we can understand that all the car companies that are present in this chart Volkswagen Group has spent the most capital on the R&D of cars. According to this list, TATA Motors has the biggest intensity in the R&D of cars, and take into account that here we are talking about the whole world, not India. Here R&D intensity means that what percentage of the sales these companies are spending on R&D of the cars? and TATA Motors has the biggest R&D intensity. This could be because the market capitalization of TATA Motors is less in comparison to the other companies present in this chart and TATA Motors is only limited to India. But obviously, since they want to grow, that's why they are spending huge amounts of money. In the R&D of their vehicles, As discussed previously almost every car brand has acquired a huge amount of debt. There is an exception as well, this brand has not acquired any amount of loan, and this company is Tesla!

How can Tesla accomplish this?

Because Elon Musk has created massive hype around him and Tesla. Due to this, the value of this company is touching the sky. A high value means that the stock price of Tesla in the stock market is very high. It is so high that the valuation of Tesla is double the valuation of Toyota. Even though Tesla has twice the brand value of Toyota. But, Toyota is far ahead of Tesla in terms of its sales since Toyota is a monstrous company. That's why the expenses of companies like Toyota are very high compared to companies like Tesla. But still, Tesla is not so small company it should have definitely acquired a certain amount of debt. However, Tesla has not acquired any debt because due to its increased share prices, they indulge in equity funding. They have acquired an almost negligible amount of debt Now, after reading this article, you might have understood, how difficult it is to operate a car company!

Next time you are about to criticize any car company blindly. You should keep one thing in mind. These companies are in a fight with many government policies and several odds as well and it takes a considerable amount of risk to deliver an affordable car to you. If you have loved reading this article please share this little piece of blog and don't forget to mention your thoughts in the comment section.

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