Times may seem hard for suppliers in North America, but analysis released by Edmund Chew’s AutoBusiness suggests that some suppliers have enjoyed earnings growth in 2002. However, AutoBusiness believe that earnings growth in 2003 could be restricted by a softening North American vehicle market in 2003. They also say that strategies for long-term success are continuing to evolve as lessons from the late 1990s continue to be absorbed.

Key points:

• Suppliers have enjoyed recent earnings growth despite the period of “profitless prosperity” for the North American OEMs
  
• Suppliers with diversified customer portfolios and high exposure to the New American Manufacturers (NAMs) have done particularly well
  
• The rewards from painful restructuring are increasingly evident as vehicle North American production levels have confounded the pessimists
  
• Earnings growth in 2003 could be restricted by softening North American vehicle production but free cash flow generation should continue at most suppliers, strengthening balance sheets
  
• Long-term survival and growth strategies for suppliers are in place.  These emphasise the need for a more rigorous approach to customer/program screening and prioritisation

North American Auto industry supplier earnings are recovering, says Colin Whitbread, Research Director at supplier analysts AutoBusiness.co.uk.

Sales at a sample of 20 leading suppliers tracked by AutoBusiness fell on average by 4.5% in 2001, but jumped 11.6% in the first nine months of 2002.  Operating profits recovered even more strongly, up 44.6% in the first nine months of 2002 on the same period in 2001.

The data, summarised in table 1, is extracted from The North American Supplier Report, sponsored by PricewaterhouseCoopers AUTOFACTS.  This report presents an overview of the environment currently facing suppliers to the North American automotive OEMs, highlighting recent trends and drawing performance distinctions between the vehicle manufacturers and their key suppliers.

Financial recovery in 2002
“We have seen a period of “profitless prosperity” for the Big Three,” says Whitbread, “driven by record volumes but declining (and now barely positive) margins and per-unit returns.  This contrasts markedly with the financial recovery evident at many suppliers.

“This upturn, which was particularly apparent in the second half of 2002, reflected the first real payoff from some significant cost-cutting and restructuring efforts made in 2001 and early 2002, coupled with higher than expected production volumes in the first three quarters of the year.”

Table 1 (at end) highlights the stresses felt by suppliers in 2001 as the slowing production and tougher pricing environment began to bite, pushing sales revenues down at 17 of the suppliers and denting operating margins severely at all but two. However, driving down breakeven levels through painful cost cutting paid dividends through 2002, pushing margins ahead as production levels exceeded analysts’ expectations. The final two columns show the strong gearing effect of even modest revenue upturns on operating profits, even allowing for the absence of one-off costs in 2002 on the profit numbers.

Despite the financial recovery in the second half of 2002, however, Whitbread sounds a note of caution for 2003.  “Break-even levels at many suppliers have been reduced, but vulnerability to a major downturn in North American vehicle production levels remains.  Earnings will be undermined if overall production proves weaker than current expectations”.  These concerns should be kept in perspective nevertheless, as free cash flow generation is expected to continue, allowing further balance sheet rebuilding, especially at highly leveraged suppliers.

Key customers drive gains
The detailed profiles in the North American Supplier Report highlight some key trends among suppliers, a number of which have helped differentiate winners from the market performers and losers in what has been a generally benign environment.

• Profitless prosperity particularly applies to the Big Three, which have taken the most dramatic metal-moving measures to keep assembly plants open, while the New American Manufacturers (NAMs) have needed less extreme incentivisation to push volumes and market shares. Suppliers with a higher-than-average exposure to these NAMs have benefited from strong volumes while enjoying a more enlightened approach to short-term pricing demands, a plus for margins.
  
• Suppliers with continuing high exposure to the Big Three have experienced varying fortunes, as General Motors has clawed back some small share gains from Ford and DaimlerChrysler. Suppliers with the highest exposure to GM, including Delphi and American Axle, appear to have done better than those which feature Ford or DaimlerChrysler as key customers.
  
• North American heavy truck production was strong through the first half of 2002, boosting the fortunes of key suppliers to that market, such as BorgWarner, Dana and Eaton, which were hit hard through 2001 as truck output slumped.
  
• North American light truck sales continued to strengthen through 2002 offering some good returns to suppliers with contracts for high-volume, strong margin product programmes. Smart suppliers identified key OEMs and model programmes in this area some years ago and are now reaping the rewards.
  
• Suppliers that have successfully exploited product and component niches and sourcing trends have also prospered. Safety equipment suppliers have proved successful at developing new products that offer first-user OEMs competitive advantage while others have leveraged technology expertise or been at the leading edge of modules and systems supply.

Supplier strategies have changed
The North American Supplier Report also shows that strategies for long-term success are continuing to evolve as lessons from the late 1990s continue to be absorbed.

 

Expert Analysis PricewaterhouseCoopers AUTOFACTS North American Supplier Report Order your copy of the full report here – it will tell you: Who supplies whom in North America, will give you profiles of 150 of North America’s most important tier 1 and tier 2 suppliers, it analyses the Big Three purchasing strategies as well as investment in North America by region, PLUS you will receive a breakdown of suppliers by region and ownership type. This major new report is of interest to anyone with an involvement in the North American automotive supplier sector – click to find out more. Find out more here.

Some suppliers remain saddled with the legacies of the M&A boom which became a key feature of the sector in the 1990s. A number, including Federal-Mogul, Hayes Lemmerz and Exide, remain under Chapter 11 bankruptcy protection while comprehensive restructuring programmes are worked out.  Most suppliers now appear more cautious with regard to the real financial impact of an aggressive M&A programme and appear willing to follow a non-organic path to growth only on a very selective basis. Magna’s recent purchase of Donnelly highlights the selective and carefully targeted approach likely to dominate in coming years.

A key strategy for suppliers going forward is that of differentiating good business from bad. Smart suppliers have already begun to evaluate business portfolios more rigorously, distinguishing contracts that just boost revenue from those that lift sales and produce returns conducive with long-term commitments to investments in new technology and product development. Tower’s recent decision to withdraw its bid for frame business on the next Ford Explorer, citing insufficient returns at the pricing levels being dictated by the OEM, highlights this trend. Federal-Mogul’s plans to return from Chapter 11 protection include a commitment to review existing and potential contracts with a view to weeding out bad (ie unprofitable) business.

“Examples of suppliers walking away from contracts which are incompatible with corporate financial targets will grow,” says Whitbread “even if this leads to short-term pain in the form of more restructuring.”

Table 1 Financial Performance of 20 leading North American Suppliers, 2001-02a

a All figures are as reported, ie are not adjusted to account for one-time charges or gains.

click on the table to enlarge