Supplier woes will worsen before they improve

ERJ staff report (AN)

By Jesse Snyder, Automotive News

For auto parts suppliers in North America, the numbers are scary - and getting worse.

Battered suppliers face growing losses. Surveys find that suppliers expect a rise in bankruptcies this year, even as production rebounds, and hold little hope for a rebound in profits before 2011.

Many suppliers entered this downturn in flimsy financial shape. Now they are rethinking strategies to cope with hard times. Analysts predict a wave of consolidation, beginning perhaps in three to six months.

"The worst is behind us on new-vehicle sales, but that doesn't fix the problems for suppliers," says Anthony Pratt, senior manager at PwC Automotive Institute. "It's going to get worse.

"Those already in bankruptcy can't meet their obligations. Those not in bankruptcy are burning cash. There's still a long way to go. We have another 12 months of pain."

North American Tier 1 suppliers will lose a combined $23.7 billion this year and won't see operating profits until 2011, forecasts consulting firm A.T. Kearney.

Retreating as plants reopen

After a first half in which light-vehicle production fell by more than half - to 3.59 million units, from 7.26 million a year earlier - suppliers need assembly plants to reopen. But filling those parts orders will take more working capital. Traditional lenders to suppliers such as Comerica Bank and Fifth Third Bancorp are retreating from auto-industry lending. Remaining private lenders may refuse to increase credit for many shaky parts makers.

Suppliers have few other sources for capital. The U.S. government has taken ownership stakes in General Motors and Chrysler but has spurned pleas for more aid beyond an initial $5 billion in loans set aside for suppliers. The money was supposed to be filtered through the Detroit 3 automakers. But many suppliers, put off by the red tape and high costs involved, chose not to apply for the money.

Analysts predict that failures will increase once suppliers are asked to ramp up production - and find they can't raise the money to do so.

Financial markets have hammered publicly owned suppliers. In the first quarter, none of the supplier stocks in the Automotive News/PricewaterhouseCoopers Total Shareholder Value Index posted a positive return on a one-, three- or five-year basis.

In the second quarter, ArvinMeritor's stock price rose - on news it managed to shed 72 percent of its auto parts operation.

Michael Benson, managing director of broker Stout Risius Ross, says merger and acquisition activity is so low for suppliers that most transactions are simple liquidations.

"There are too many sellers," he says. "Buyers can't finance a purchase anyhow, so they are waiting. Most figure, 'Why buy now, when in three months we can buy it cheaper?'"

Stock prices for SRR's Automotive Supplier Composite, made up of 20 diversified suppliers, fell 52 percent from June 2008 to June 2009. During the same period, the S&P 500 index fell 64 percent.

Different cycle

In an industry renowned for cyclical swings, the traditional supplier strategy is to hunker down, cut costs and wait for vehicle sales to rebound to previous levels. But that strategy may not work this time because this cycle is different.

The sales collapse has been deeper and faster than usual. For nine straight years, annual sales topped 16 million light vehicles, spurred in part by consumers' feeling flush because of an inflated housing market. But 2008 sales crashed to 13.2 million. This year, sales may slide below 10 million.

Ideally, automakers would have reinvested profits from the fat years in preparation for the lean ones. But amid the strong overall market, the Detroit 3 continued to lose market share and money. They increased foreign sourcing of parts and diverted their investment into overseas business.

Suppliers stepped up their overseas operations, following their traditional customers abroad and diversifying their customer base. The additional investments soaked up much of the profits from that near decade of high volume in North America.

Simply making deeper cuts won't work, says Paul Elie, a partner at PricewaterhouseCooper's Detroit-based automotive transactions consulting unit. "Suppliers must change their processes rather than just laying off people," he says. That means resizing companies to match reduced long-term demand by consolidating and shedding unneeded assets.

Many suppliers have obligations they cannot shed easily. Those include pension obligations, large ranks of retirees and long-term leases on equipment that is no longer needed. "Some suppliers can't do that without filing bankruptcy," Elie says. "They need that intervention."

But there is a big deterrent, he says: "Usually companies in bankruptcy can't bid on new business - and that's the lifeblood of a supplier."

As conditions worsen, suppliers are reassessing survival strategies. Some have begun selling assets, abandoning unprofitable lines of business or buying rivals.

In a recent survey of 250 supplier executives by SupplierBusiness and A.T. Kearney, a majority say they are likely to downsize automotive operations and open a nonautomotive unit.

"It's not surprising that so many suppliers want a nonautomotive operation," says Dan Cheng, who heads Kearney's North American automotive practice. "But it's harder than they think it is. It takes time to invest to diversify manufacturing capacity."

Supplier ArvinMeritor Inc. is leaving the auto sector. It has sold most of its light-vehicle assets as it refocuses on parts for heavy commercial vehicles.

Consolidators are emerging. Starting in 2005, investor Wilbur Ross used liquidation-priced acquisitions to build his automotive supplier IAC Group. Its $2.43 billion in 2008 parts sales to automakers in North America made it No. 17 on Automotive News' list of the top 150 suppliers in North America.

In June, IAC bought nine European plants from bankrupt German supplier Stankiewicz. IAC Chairman Ross said then that the purchase boosted IAC's know-how in automotive carpet and acoustic materials. "IAC, already a leader in the segment in North America, now will be a global leader in those products," he said.

"There are deals to be had," says IAC Group spokesman David Ladd. "If you see growth in consolidation of the interiors segment, we expect to be there."

Look for consolidation

Broker Benson predicts new consolidators will emerge in "all automotive commodity sectors."

He expects merger and acquisition volume to begin rising in three to six months. Private-equity players that have been on the sidelines are regaining interest in the sector as they sense "the beginning of the industry's recovery period is imminent," he says.

"Private equity is OK about running into a burning building," Benson says. "Lenders want to come in later. The challenge for private equity is getting lenders and sellers in at the same time."

But private equity will remain cautious until it can see which car brands and platforms will still exist, Benson says. "If you start running down a book of business and marking which programs are uncertain, pretty soon you have a scary page. It's hard to know what to buy when so much is uncertain."

From Automotive News (A Crain publication)