The rating outlook is stable for Moody’s Investors Service’s rated group of Japanese auto suppliers – five companies with significant market shares – as their growth mitigates price pressures, the rating agency said in a new report.

“Auto parts suppliers’ profitability is greatly affected by production volumes of automakers, which remain strong in Japan” said Junichi Yamaki, Moody’s senior vice president and author of the report, Japanese Automotive Suppliers Outlook.

“Japanese auto parts suppliers will likely continue to benefit from growing auto production volumes, which should result in margin improvements, mitigating margin pressure from OEMs.”

The report said that although the auto parts suppliers’ operating performances should continue to be favourable, the pressure from OEMs is likely to remain severe as high petrol prices cause a global demand shift to small cars from more lucrative large models, and OEMs’ tightening quality control could drive suppliers’ product assurance costs to increase.

Rising prices of copper, aluminium, rubber and other raw materials are also having a negative impact on auto parts suppliers’ profitability, Moody’s noted, and the companies therefore still to need to reduce manufacturing costs by introducing more efficient product design and manufacturing systems.

The report also said that Japanese auto parts suppliers are characterised organisationally by a high degree of vertical integration within the major automotive companies, and that Toyota and Honda are now seeking closer relationships with their affiliated auto parts suppliers by increasing equity holdings and/or by arranging mergers between group companies.

“We see the main reason behind this tightening of group relationships as OEMs’ need to control suppliers’ R&D management policies, in order to promote processes that will improve quality and efficiency and reduce costs, as well as to protect themselves from potential hostile takeovers,” added Yamaki.

Moody’s said that retained cash flow has increased across the industry, driven by stronger earnings, but that increased cash flow generation has not resulted in significant improvement in debt capitalisation ratios for some of the rated issuers.

Japanese auto parts suppliers face continued high capital expenditures in response to Japanese automakers’ increased production and the expectation that demand will grow for their key products. However, Moody’s expects the rated Japanese parts suppliers to largely maintain their balance sheet structures over the intermediate term despite the associated ongoing capital expenditure requirements.

Although the auto parts suppliers’ operating performances continue to be vulnerable to cyclical downturns in the regional economy and in the automobile industry, they have adopted various cost-cutting measures aimed at lowering their breakeven points. As a result, in Moody’s view, the rated companies have increased the resistance of their operating performances to market downturn.