Have GM and Ford Cut Production Far Enough?

U.S. auto sales continue to roll along at near-record levels. However, the market isn't growing anymore, and shifts in consumer tastes have left top automakers like General Motors (NYSE: GM) and Ford Motor (NYSE: F) with too much inventory of some models.

Both auto giants have reduced their production in response to rising inventory levels. Ford was quick to do so last year and GM has followed its lead in early 2017. Unfortunately, it still isn't clear whether they have gone far enough or if additional production cuts will be necessary.

Inventory falls -- then creeps up again

In recent years, December has been the strongest month for auto sales in the U.S. This typically allows automakers to sell off some of their excess inventory. The faster sales pace also makes inventory levels seem leaner than they really are, because inventory is often measured in terms of "days supply" -- i.e., how many days it would take to sell the inventory at the previous month's daily selling rate.

For example, GM delivered more than 319,000 vehicles during a strong December. This allowed it to reduce its inventory by a modest 3.3% during the month, from 874,162 units to 844,942 units. Yet its days supply plunged from 87 days at the end of November to 71 days at the end of December because of the fast sales pace in that month.

By contrast, January is one of the weakest months for auto sales. GM sold 195,909 vehicles last month. While that was only down 3.8% year over year, it was far below the December total. As a result, inventory ballooned to 878,590 units, which now translates to 108 days supply.

GM has too much inventory for several of its car models. Image source: General Motors.

A similar scenario has played out at Ford. Total stock increased by 38,077 units (or 5.9%) during January. That was enough to send days supply soaring from 73 at the end of December to 103 by the end of January.

Production gets slashed

Ford was relatively quick to recognize last year that production was outpacing demand, particularly for passenger cars. As a result, it implemented significant production cuts during the second half of the year, helping reverse its inventory buildup. As a result, dealer stocks were down 8% year over year at the end of January. (Including vehicles in transit to dealers, inventory was down 5%.)

By contrast, GM continued building vehicles at a breakneck pace throughout 2016. As a result, it ended January with inventory up nearly 40% year over year.

The General already began cutting production last month. Some of the extra downtime was reflected in the January inventory numbers, but cuts at two factories weren't implemented until near the end of the month. Additional downtime is planned for later in the year at factories that specialize in out-of-favor small cars.

Is it enough?

Even with its proactive production cuts, Ford still ended January with more than 100 days supply in inventory, including vehicles in transit to dealers. However, at least the absolute number of vehicles in inventory is declining. The main problem is slowing sales of various car models. (Trucks and SUVs are still selling well.)

Indeed, Ford has 25% fewer cars on dealer lots than it did a year ago, but as measured by days supply, its inventory position has barely improved. Assuming that Ford needs to sell a certain number of cars to balance out its SUV and truck sales (to meet fuel economy standards), it may need to push discounts a little higher to prop up sales.

Meanwhile, General Motors simply has too much inventory on its hands. The company made a point of noting that it entered January with low inventory in popular market segments like SUVs, midsize trucks, and compact crossovers. However, if that's true, it just means that inventory levels are even more bloated for other models.

As the sales pace picks up this spring, the days supply figures at Ford and GM should recede to more reasonable territory. Even so, General Motors probably needs to cut its car production even further to properly align its inventory with demand.

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Adam Levine-Weinberg owns shares of General Motors. The Motley Fool owns shares of and recommends Ford. The Motley Fool recommends General Motors. The Motley Fool has a disclosure policy.