Auto Parts Makers in Trouble

AUTO SUPPLIERS IN TROUBLE
Grant Thornton LLP's View
By Steve Purdy
TheAutoChannel.com Detroit Bureau

Detroit March 15, 2009; Reporters listened to a sobering auto industry analysis this week at a gathering of the Detroit Automotive Press Association, where Grant Thornton partner, Laura Marcero, tried to offer an optimistic view of the future of the auto industry and the US economy while cautioning that the imminent collapse of the supplier base could bring it all down. She noted that most automotive suppliers, from tier ones on down, were struggling to stay afloat when US production was at its peak, and now are teetering on the abyss as production wanes.

Her optimism is predicated on the suppliers getting together and selflessly orchestrating a comprehensive consolidation. A long shot, it would seem.

Grant Thornton is a world-wide partnership of individual tax, audit and advisory companies with deep expertise in the automotive supplier business. Six partner companies around the world serve clients in 100 countries.

We’ve recently seen doomsday scenarios that predict a meltdown of the entire manufacturing sector of the US economy should GM fail. The demise of GM would immediately bring down the supplier base that makes parts, components, subsystems, materials and everything else for not just GM but all auto manufacturers in the US. That, of course, includes the Germans, the Japanese and now the Koreans as well. The supplier community as a whole just does not have the resources to withstand such a shock to the industry.

“Without a solution we’re looking at a collapse in the industry,” says Ms. Marcero.

The problem is threefold, and has been brewing for a long time: overcapacity, lack of liquidity and profitability. Many suppliers have been tooled up for the full-bore 17-million-units-a-year production level and have been too slow - or haven’t been able at all - to downsize (or “right-size” if you prefer that euphemism). And, for years the OEMs have been squeezing the margins out of the suppliers businesses in order to be competitive with challengers throughout the world, hurting both liquidity and profitability for all suppliers. Now, of course, with a frozen banking system, the little liquidity that was available is encased in an economic iceberg.

So what is the solution – or solutions?

We are so close to the edge that any solution must begin immediately – 30 to 90 days is all we have, Ms. Marcero cautions. Most importantly, she says, the suppliers must get together immediately and instigate a rapid consolidation of the supplier base. They must decide selflessly who will be the consolidator and who will be the consolidatee. Stronger companies (ones that are already right-sized) must take the lead. I can’t imagine that can be done without a great deal of divisiveness. But, Ms. Marcero insists, consolidation is urgent and unavoidable.

Government can help with the liquidity issue by guaranteeing receivables and inventory. Notwithstanding an increasing “bailout fatigue” it is necessary to relieve some of the time pressure to get this job done. Other government policies can stimulate demand for cars and light trucks. Though that may create artificial demand, it may be helpful in getting the industry headed back toward the 14-million-unit year, the level at which everyone thinks the market will finally settle. In terms of legal issues bankruptcy laws need revision and anti-trust laws need serious attention to allow the collaborations needed.

Speaking of receivables, there needs to be a new philosophy around managing those. The method of paying suppliers 60 or 90 days out just won’t work anymore. Those payments need to out and get moving through the system much faster – OEMs to tier ones to tier twos, etc. – to prevent the risk of failure from the bottom up.

The OEMs, of course, have to be intimately involved in the whole process. They can also help stabilize the supplier base by working more cooperatively with them and by more realistic production planning which will help the suppliers plan more efficiently themselves.

Banks can help by working on liquidity problems. TARP has not had any effect on loosening credit, as we all know, and the banks have continued to avoid any involvement in the auto sector. Perhaps with government guarantees, and OEM assurances that the supplier in question is essential, the banks might provide suppliers with loans in excess of what available collateral might justify – “air ball” loans . That sounds pretty far-fetched, but with the backing of government and the support of the OEMs Ms. Marcero thinks that’s possible.

Finally, the solutions will have to be enthusiastically embraced by all these major constituents – the suppliers themselves, the OE Ms and the government (from whom the money, or at least the loan guarantees, must flow.

So where is the optimism, you ask?

Ms. Marcero wrapped it up by saying, “Getting all of this work done with the clock ticking will be hard, but the task is not insurmountable. The rewards for successful execution will be great. With all of the cost and capacity being wrung out of the system, the auto industry may become spectacularly profitable as demand climbs back toward trend levels.”

“. . . spectacularly profitable . . .” She says.

I like the sound of that.