US: Over a third of NA suppliers "in fiscal danger"
A senior executive of global corporate advisory firm AlixPartners has said that no less than 38% of all automotive suppliers in North America are in "fiscal danger," meaning that they could face insolvency within 24 months or less unless they take urgent counteractive measures.
He also said that 24% of all suppliers globally face the same danger. That would be in addition to the $60bn in major supplier bankruptcies in the U.S. alone since 2001.
Speaking at a meeting of the Original Equipment Suppliers Association (OESA) in the US, John Hoffecker, a managing director of AlixPartners, said the company's 2006 automotive vehicle industry review and outlook study of 104 automotive suppliers, 22 automakers, 18 heavy vehicle producers and 32 automotive conglomerates worldwide showed that a pronounced divergence is taking place between top-performing OEMs and suppliers and those in the lowest-performing quartile; that the Chinese automotive market has cooled off to such a degree that a big shake-up is most likely brewing there; and that auto suppliers, in particular, need to do much more than what they have done to date to accelerate cost reductions, improve working capital and better manage product innovation if they want to stay competitive.
"Suppliers and automakers alike are at a crossroads," said Hoffecker, "and only those ambitious enough to take bold actions today will be winners of tomorrow. Our financial measuring tools show that no less than 38% of North American suppliers are in 'fiscal danger,' which means they run the risk of insolvency within 24 months unless counter-actions are taken. Moreover, 24% of all suppliers worldwide face the same danger. That is, unless suppliers take much more urgent actions to strengthen their financial positions, from maximising cash flow to improving working capital to enhancing revenue strategies and beyond."
Hoffecker added that in 2005 the bottom 25% of suppliers worldwide experienced a significant deterioration in financial performance, with earnings before income tax (EBIT) falling 4.4 percentage points, to a negative 0.1%- whereas EBIT for suppliers in the top-performing quartile actually increased, by 0.8 percentage points, to 9.2%. That mirrors the divergent performance for automotive OEMs globally where the top-quartile performers improved EBIT by 0.2 percentage points, to 9% overall, and the bottom- quartile performers suffered the loss of 4.9 percentage points, to a negative 3.6% EBIT percentage overall.
Meantime, he indicated that while top-performing North American suppliers are maintaining return-on-capital-employed (ROCE) numbers at levels comparable to those of the highest-performing industries of any kind, "it's a much different story for suppliers at the bottom and in the middle."
"Despite its woes in some areas, the auto industry in general and the auto supply business in particular remains very good industry to be in," said Hoffecker, "just so long as you have the right strategy and flawless execution. However, for suppliers in the middle or at the bottom, cash and liquidity issues are becoming even more critical. Our findings show there is widening gap in the ability to service debt between the top-quartile companies and the rest of the pack."
He noted that these issues are translating into significant market capitalisation differences by region, pointing out that 21 of the top 25 suppliers as measured by total value creation (change in market capitalisation) in the past two years are Asian, while 15 of the 25 suppliers at the bottom of that list are North American. He also noted that North American suppliers are trailing far behind both their Asian and European counterparts in investment in research and development spending, a critical element in developing innovative products for future returns.
Working capital is also an across-the-board problem, he said. In fact, according to the study aggregate working capital efficiency for suppliers worldwide has not changed markedly since 1995, and while American suppliers have also seen a slippage in inventory turns recently, few suppliers in any region have been able to match accounts-payable turns to accounts-receivable turns. However, the study did find that suppliers as a whole globally are turning their assets more than 25% faster than OEMs.
Hoffecker said that the $72bn components market in China has become even more fragmented, which could represent an opportunity for western suppliers. At the same time, though, he had sober news for companies looking at China as a panacea for their woes, noting that China for the first time became a net exporter of vehicles in 2005 and that over-investment there has led to lower profitability and massive price-cutting for the OEMs.
"The gold rush in China is officially over, as least as far as easy profits goes," said Hoffecker. "Even though we forecast that 34% of the global auto industry's growth by 2010 will come from China, our analysis tells us that the many automakers there are headed toward a major reckoning, as we predict that capacity utilisation will level off at the current low levels, in the neighbourhood of just 50%, and that today's price-cutting trend will continue. And, of course, that's a double-whammy for Western suppliers and OEMs alike, as that overcapacity will put even more pressure on China to export. That's certainly not good news at a time when the inflation-adjusted price of a new car in the United States over the last decade is on the same downward curve as the price of apparel."
In the heavy vehicle section of the study, the study showed that even though both the operating margins and return on capital of heavy truck makers is significantly higher than those of light-vehicle OEMs, the fastest-growing truck makers aren't necessarily the most profitable.
"Increasing globalisation is the number-one key driver forcing the need for increased efficiencies in auto markets all around the world," said Hoffecker. "But, compared with other industries, not to mention compared to where they certainly are going to have to be long term, suppliers and automakers alike are mostly just in the beginning to middle stages of this race. Some suppliers and OEMs have turned in very impressive performances so far, but the performance of many companies remains spotty in terms of organisation, process and, especially, execution."
"Companies in this industry are going to have to achieve at least a 10 to 15% productivity improvement over the next two to three years just to stay in the game. And, the only way that's going to happen is adopting a far greater sense of urgency, and a holistic, unsentimental view toward every aspect of the business-often the hardest thing of all for management teams to do."