•  Suppliers report improving financial health, but significant challenges persist
Suppliers have made financial progress this year, but significant challenges remain

Suppliers have made financial progress this year, but significant challenges remain

Part 1 of this briefing reviews the recent financial results of a sample of major global auto suppliers; Part 2 highlights recent developments in industry structure, including M&A and IPO activity and corporate restructuring.

Overview

As the latest financial reporting season for the major auto suppliers draws to a close - the first nine months of the financial year for North American and European suppliers and the first half for the Japanese - a sense of optimism for short- and medium-term prospects has remained a dominant theme.

Despite rocky demand conditions in some areas and specific markets, the overall environment, especially in the North American light vehicle and heavy truck sectors, has provided many suppliers the opportunity to maintain revenue growth, strengthen margins and further boost cash generation. In turn, this has increasingly provided adequate financial resources to address the needs of business growth/expansion models and the expectations of customers and shareholders/owners.

However, this generally healthy financial picture can't fully disguise significant ongoing challenges for the supplier sector, challenges that require continuing focus on strategic issues such as product portfolio positioning, technology/innovation, customer and market profiles, as well as operational capabilities in areas such as cost and asset efficiency. Generation of improved margins and cash flow resulting from favourable vehicle demand trends can provide a necessary, but not automatically sufficient, environment for success, especially in an era of evolving customer demands (global expansion, megaplatforms, etc) and vehicle technology trends (alternative powertrains, semi-/fully-autonomous driving, connectivity, etc).

For many suppliers, current positive financial results represent a continuation of a favourable trend that has now become established over recent years. This has come about as vehicle demand has recovered, capacity utilization has been rebuilt and the positive effects of restructuring (resulting in leaner manufacturing operations and lower fixed costs) have kicked in. Data from PwC indicate that for the Global 100 (largest suppliers by automotive revenue), total sales increased 4.8% between 2012 and 2013 (US$855bn to US$896bn) but EBITDA rose 11.6% over the same period - from US$87.1bn (10.2% margin) to US$97.2bn (10.9%).

Inevitably, headlines in the recent reporting season have focused on the performance of North American-headquartered suppliers. Most of the major tier ones have geographically diversified their businesses in recent years, to follow customers overseas and to capture growth in rapidly developing markets such as China. However, for many, the buoyant light vehicle and commercial vehicle production environment in the US, Canada and Mexico in recent quarters has underpinned revenue and earnings gains (especially as many overseas activities are only equity accounted due to ownership structures).

Analysis of the performance of 11 key North American suppliers by just-auto indicates that in the first nine months of 2014, these companies saw both modest revenue gains and more significant adjusted (for restructuring etc) EBITDA increases. These companies - Magna, JCI (FY2015), TRW, Lear, Delphi, Tenneco, Borg Warner, Federal-Mogul, Visteon, American Axle and Dana - reported aggregate automotive-related revenue of around US$124.9bn in the January-September 2014 period, up approximately 7.1% from the total of US$116.7m in the same period of the previous year. Aggregate EBITDA is estimated to have improved around 12.7% over the same period, lifting the average overall margin for the 11 by around 50 basis points (bp) - to 10.4% from 9.9% in the first three quarters of 2013. With one or two exceptions, this margin gain was remarkably consistent across the supplier group, despite wide differences in product portfolios, geographical diversity and customer dependence.

Magna performance typical of North America

As the North American supplier with the highest revenue in the first nine months of 2014 - US$27.25bn, up 6.2% year-on-year from 2013's US$25.66bn - Magna's performance presents a typical picture. Although atypically having significant revenue resulting from its vehicle assembly activities in Austria, Magna's principal business - encompassing body, chassis, interior, exterior, seating, powertrain, electronics, vision and closure systems - is somewhat of a benchmark for the supplier sector, especially as its 312 manufacturing operations, 83 product development and sales centres and over 130,000 employees are spread across 29 countries.

Unsurprisingly, Magna recorded growth of 9.8% in production revenue in North America in the first nine months of 2014 (US$13.58bn, versus US$12.37bn), outperforming estimated North American vehicle production growth of 5.3% (12.79 million units, versus 12.15 million). Year-on-year revenue growth in Asia was 19.9%, helped by new programme launches in China (Audi Q3 and Ford Modeo) but just 3.7% in Europe, reflecting lower volumes on certain programmes and net customer price concessions and despite a US$181m reported gain resulting from the strengthening of the Euro against the US dollar. Magna does not report EBITDA by region, but its adjusted EBIT figures show that a 31.7% (US$462m) year-on-year improvement at group level between the first nine months of 2013 and the latest nine-month period relied heavily on improved profitability in North America. EBIT in this region increased US$282m, or 24.1% (US$164m or 12.8%, excluding a one-off amortization charge in 2013), while in Asia it rose 86.4% and in Europe 26.9%. The very positive development in Asia was driven by new product and facility launches and higher equity income, lifting the margin to 8.2% from 5.4%, while in Europe the 60bp improvement in margin (3.1%, versus 2.5%) reflected the positive impact on costs of recent restructuring and downsizing, productivity and efficiency gains and the higher production revenue.

While the impact of higher production volumes, especially on capacity utilization, has been a widespread positive for most suppliers, as have the cost improvements resulting from recent (and in many cases, ongoing) restructuring, Magna's results also reflect some enduring challenges for many suppliers that restrict revenue and margin growth. For example, pressure for pricing concessions from customers is a recurring theme, something that Magna has acknowledged in North America, Europe and Asia. While unquantified, these concessions, if not offset by matching cost reductions, continue to be a real burden. Recent OEM/supplier relationship surveys have again thrown up the spectre of OEMs pushing the boundaries of cost reduction, driving demands for what are regarded as unsustainable annual price reduction targets. Although annual reductions of around 2-3% have become a norm, surveys have indicated that it is not uncommon for cuts of 5% to be requested, with some OEMs pushing for 10% reductions in extreme cases.

OEMs envious of supplier margins...

With a number of major OEMs still struggling to lift their own profitability, especially in Europe, this is likely to prove an enduring battlefield. While perhaps not entirely representative of the typical OEM view, FCA CEO, Sergio Marchionne, was reported as saying in an outspoken comment in August 2014: "I am envious of some of the margins that I see coming out of our suppliers, absolutely mesmerized by some of the double-digit performances that I've seen coming out of the supplier base. And unfortunately, when I see this, my blood pressure goes up. There's not a single doubt that we will approach our supplier base in a constructive way to find a way in which we can effectively at least participate in their well-being, and perhaps allow them to rub off some of their newfound wealth onto us."

As the owner of Magneti Marelli, a leading supplier of lighting, powertrain, electronic systems, suspension and emission control equipment, which relies on FCA for around 40% of its revenue, Marchionne is probably a little more relaxed about that supplier's EBIT margin, which was 2.6% in the first nine months of 2014, almost unchanged from the 2.4% reported in 2013. However, this margin is at the low end of the profitability range of European suppliers so far in 2014, although the true picture is a little opaque as a number of the largest, including Bosch and ZF do not report quarterly financial details, while others, including Valeo and Faurecia only report revenue performance at the nine-month stage.

Modest profitability gains in Europe

Analysis by just-auto based on the performance of nine leading European suppliers in the first half of 2014 and the nine-month period ending end-September, indicates that, in aggregate, these companies have also seen modest revenue growth and profitability gains in 2014. Excluding Bosch and ZF, which do not report half-year and nine-month financial details, the nine leading suppliers reported relevant automotive revenue growth of around 3.4% year-on-year in the January-June 2014 period, accompanied by EBITDA growth of around 8.4%, lifting the aggregate margin to 11.2% from 10.7%. Based on more limited data for the January-September period, revenue growth was approximately 3.6% while earnings improved 3.5%, leaving an aggregate YTD margin of 12.1%, unchanged from the previous year's figure. As noted below, these aggregate results were negatively distorted by the results at Continental, the major supplier in the sample, which has incurred significant one-off cost hits to reported profitability in 2014.

This overall picture obviously comprises the results of a variety of suppliers competing in differing product sectors and with differing geographic revenue profiles, but the results of Continental, like Magna in North America, being the most comprehensively reported and covering a multitude of segments, inevitably dominate the group.

Continental

With two product groups - Automotive (Chassis and Safety, Powertrain and Interior) and Rubber (Tires and ContiTech) - Continental reported revenue of EUR25.6bn in the first nine months of 2014, 2.7% ahead of the 2013 total of EUR24.9bn (+4.7% excluding consolidation and exchange rate effects, the latter reducing reported revenue by EUR650m). Automotive Group revenue increased 3.0% while Rubber Group revenue rose 2.1%, the former seeing consistent increases in all three segments. Reflecting market trends (and similar to results at Autoliv), Chassis and Safety noted a 47% increase in sales of advanced driver systems, but, conversely, Powertrain acknowledged its Hybrid Electric Vehicle business unit saw falling sales for electric motors and battery systems, although this was offset by rising volumes for on-board power supply systems.

Despite this revenue growth, profitability took a turn for the worse in Q3, group EBITDA declining 9.0% to EUR1.20bn (margin of 13.9%, versus 15.8% in Q3 2013), leaving the nine-month total almost flat at EUR3.81bn (14.9%; 15.3%). This Q3 drop was focused entirely in the Automotive Group, the reported Q3 and 9M totals falling 22.7% and 7.3%, respectively, pulling EBITDA margins down to 9.3% (12.6%) and 11.2% (12.4%), although it should be highlighted that high one-off costs, most notably impairment losses on physical assets in the Powertrain business, significantly distorted results. Adjusting for these items, the Q3 EBITDA margin would have been 15.1%, rather than the 13.9% reported.

Dr. Elmar Degenhart, chairman of Continental's Executive Board, commented in early November 2014: "We are keeping our sights set firmly on our target for the adjusted EBIT margin, which we raised to around 11% after the first half of the year, and we even consider it realistic that we may slightly exceed this level at the end of the year. Sales are expected to total approximately EUR34.5bn this year, despite the negative exchange rate effects of EUR650m that we recorded in the first nine months. However, the development of the exchange rates relevant to us is currently unlikely to change significantly by the end of the year."

In the light of the complexity of recent quarterly results, perhaps a more telling perspective is that in the 2009-13 period, Continental's adjusted EBITDA rose in an unbroken upward trend from EUR2.35bn to EUR5.09bn.

Japanese suppliers turn down

To complete the round-up of recent global supplier financial performance, data for 12 Japanese suppliers in the first six months of their current fiscal years (ending 31 March 2015) shows modest aggregate year-on-year revenue growth of 4.6%, but a downturn in profitability based on operating income (revenue minus cost of sales and S,G&A expenses). just-auto analysis indicates an aggregate operating margin of 6.0% for the group in the April-September 2014 period, down from 6.8% in the same period of 2013, although within the group five suppliers - Akebono, NGK, NSK, JTEKT and Tokai Rika - reported improvements.

Inevitably, results from Denso and Asian Seiki, with revenue of JPY2,070.1bn and JPY1,434.9bn, respectively in the latest six-month period, in total accounting for around 54% of group revenue, dominate sector results, and in both cases modest revenue rises (4.2% and 3.4%, respectively) were accompanied by operating income falls (16.1% and 15.3%, respectively). Denso's operating margin therefore fell 190bp to 7.8% while Aisin Seiki's fell 130bp to 4.9%.

In Denso's case, the root of the margin decline was in the domestic business, with revenue falling just 2.6% year-on-year but operating earnings plummeting 26.4%, thereby dropping the margin 260bp to 8.2%. This was exacerbated by a 150bp margin fall in Asia/Oceania. In contrast, margin gains were evident in North America (70bp) and Europe (120bp), although these are low-margin areas relative to the domestic market. Analysis of factors undermining profitability shows that the benefits from variable cost reductions (JPY15bn), production volume increases (JPY13bn) and currency changes (JPY8.0bn) were outweighed by labour cost increases (JPY18bn), higher depreciation (JPY10.9bn) and other factors. Although the yen has continued to weaken, the positive impact on profitability has waned significantly from the previous fiscal year (as it has for many Japanese suppliers). The forecast positive impact for the whole of the current fiscal year is now estimated at JPY15bn - down from the JPY111.5bn reported in the previous year.

Nobuaki Katoh, president and CEO of Denso commented on the half-year results: "Sales {revenue] increased due to the production volume increase. Despite cost reduction efforts and the increase in production volume, R&D expenditures and investment costs for strengthening future growth led to the decrease in operating income."

At Aisin Seiki, which relies on Toyota Group business for around 64% of its revenue, an increase in this revenue was driven by higher exports of automatic transmissions and overseas production volume increases in North America and China, while the 130bp fall in the operating margin reflected higher depreciation costs, R&D costs etc associated with investment in building global business bases. Like Denso, operating earnings fell in Japan (-21.2%) and Asia & others (-21.1%), but improved in North America (+47.6%) and Europe (+31.3%) - albeit to very low absolute levels. Importantly, despite the overall fall in earnings, the company continued to report significant cost structure improvements (JPY14bn, with JPY30bn forecast for the full current fiscal year, unchanged from the previous year) as well as a modest gain from forex trends (JPY4.3bn). JPY8.9bn of forex gains are forecast for the full year, again like Denso, down significantly from the recorded total (JPY39.9bn) in the previous fiscal year.

The sheer complexity of the major issues determining individual supplier performances across the regions makes an overall assessment of trends difficult, but it is clear that a generally positive picture prevails, particularly in North America and Europe.

For example, global suppliers with exposure to the light and commercial vehicle markets in the US are generally performing well and lifting profitability and cash flow, with those, like American Axle, supplying the particularly buoyant pick-up and SUV market, performing best. For Japanese suppliers active in this market, reported returns continue to be boosted by a weakening yen, while for European suppliers the picture is mixed. Valeo noted in its half-year results that changes in exchange rates had a negative impact of 3.1% on consolidated revenue, reflecting "the significant depreciation of emerging market currencies as well as the yen and the dollar against the euro."

Similarly, although production growth has slowed in China, leading Autoliv, for example to report lower-than-expected expansion in the country based on adverse mix and lower overall production, the country is still a major growth target for most suppliers. Even Autoliv reported year-on-year revenue growth in the country of 12.0% in the first nine months of 2014, with Faurecia seeing 20.6% growth in Q3 and Valeo 31.7% growth (nine months), the latter two significantly outperforming actual production growth as a result of heavy investment in the country in recent years.

In contrast, suppliers with business in South America have seen a major negative impact on their activities, Valeo reporting a 16.0% year-on-year fall in reported OE revenue in the region in the first nine months of 2014 (-2.7% in Q3 alone). Faurecia reported a similar drop, with reported product revenue down 25.8% so far in 2014 (-23.6% in Q3), exacerbated by adverse exchange rate developments. Faurecia noted: "The economic situation [in South America] continued to deteriorate, leading automakers to revise their production programmes significantly downward. As a result, Faurecia now expects production to contract by around 15% in 2014."

Next: Part 2 of this briefing highlights recent developments in industry structure, including M&A and IPO activity and corporate restructuring.  

Global Supplier Sector Revenue & EBITDA Performance, 2013-14

  2014 Revenue 2013 Revenue % change 2014 EBITDA c 2014 EBITDA/Revenue 2013 EBITDA 2013 EBITDA/Revenue % change
NA Suppliers (US$m) a 124896 116653 7.1 12959 10.4 11501 9.9 12.7
European Suppliers (EURm) a 45836 44230 3.6 5550 12.1 5364 12.1 3.5
Japanese Suppliers (JPYm) b 6470530 6184230 4.6 388958 6 417713 6.8 -6.9

a Jan-Sep
b Apr-Sep
c Japanese suppliers = operating profit