Tuesday, April 19, 2005

Parts makers feel pressure

Automakers' cuts in production, rises in cost of materials spelling big trouble.

By Brett Clanton / The Detroit News

Credit problems Since January, credit ratings agency Standard & Poor's has downgraded several Metro Detroit suppliers amid difficult industry conditions.   Collins & Aikman Location: Troy Products: Auto interior components Reason for downgrade: Poor cash flow, high debt, liquidity under pressure.   Dura Automotive Systems Inc. Location: Rochester Hills Product: Driver control, door controls, body and glass components Reason for downgrade: Weak operating results, high debt, liquidity under pressure.   Metaldyne Corp. Location: Plymouth Township Products: Variety of metal parts for drive train, chassis applications Reason for downgrade: high debt, constrained liquidity.   Tower Automotive Inc. Location: Novi Products: vehicle body and suspension components and modules Reason for downgrade: Downgraded twice in 2005, first because the company filed for Chapter 11 bankruptcy protection and again because of heightened short-term liquidity pressures. Source: Standard & Poor's Supplier woes Auto suppliers face a litany of profit pressures that shows no sign of letting up. Among the challenges: • Production cuts from General Motors Corp. and Ford Motor Co. in the face of declining sales • Persistently high costs for raw materials such as steel, plastics and energy • Ongoing price-down demands from automakers • Automakers' shift away from pre-paying for parts, which helped bulk up balance sheets • Declining sales incentives and rising interest rates that could slow car and truck demand Source: Standard & Poor's Comment on this story Send this story to a friend Get Home Delivery

Industry headwinds that have wreaked havoc on the U.S. auto supply industry in recent months, driving some players into bankruptcy, are continuing to put pressure on parts makers and could bring more pain if the situation does not improve.

A new report by credit rating agency Standard & Poor's shows the outlook for suppliers in 2005 is clouded by many of the same challenges as last year, including production cuts by Detroit automakers, persistently high raw material costs and ongoing price pressures. A change in how automakers pay suppliers is also creating worries.

The woes facing suppliers are likely to be reflected in quarterly profit reports this week from some large parts makers, including Southfield seat maker Lear Corp. which recently warned investors that earnings would not meet expectations.

But that may only be the start of the bad news if negative economic factors continue to line up against the industry -- as they appear poised to do - even as U.S. auto sales appear healthy.

U.S. demand for new cars and trucks so far this year has been roughly in line with 2004 levels -- 16.9 million units on an annualized basis -- and close to the all-time record.

But automakers are cutting incentives, interest rates are rising and consumers are lengthening auto loan terms, all of which appear likely to "dampen the extent of any strengthening of demand related to general economic growth," S&P analyst Martin King said in a research note to the report.

The growing weakness of large and midsize sport utility vehicle sales is of particular concern for suppliers closely tied to General Motors Corp. and Ford Motor Co., which depend on SUV sales for a "highly disproportionate share" of their earnings, Martin said.

As sales have fallen, GM has cut vehicle production 12 percent in the first quarter and plans a 10 percent reduction in the second quarter. Ford slashed production 10 percent in the first quarter and plans a 1 percent cut in the second quarter.

The cuts have sent shock waves through the supplier industry, prompting a rash of profit warnings, and fear that additional cuts will be necessary in the months ahead if automakers cannot pare down their bloated vehicle inventories.

Another cause for concern is that full-year costs for energy, steel, plastics and other commodities are expected to exceed last year's levels, when an unexpected surge in prices nearly broke the backs of several parts makers. Some suppliers had planned to seek relief from automakers but they are also facing intense profit pressure and may have trouble coming to their rescue, which would leave suppliers to absorb the added costs.

"The commodity pricing has definitely been tough," said Mike Wall, analyst with industry forecaster CSM Worldwide in Grand Rapids. "It's just been another twist suppliers have had to deal with on top of everything else."

The rising cost of employee health care and pension and wage costs have also cut into supplier profits. And a recent change in the way Detroit automakers pay for parts has hurt suppliers' balance sheets as well.

The Big Three have either ended or are ending "fast-pay" accounts receivable programs to suppliers. The programs paid suppliers before parts were delivered and provided a vital source of cash flow for supplier operations. In their absence, suppliers are seeking alternative financing to fill the gap and to reassure investors and analysts that they can pay the bills.

"Cash flow has always been king," said David Andrea, vice president of the Original Equipment Suppliers Association, a Troy-based trade group that represents auto suppliers. "But in a period when revenues are tight and costs are escalating, you need to focus even more on it."

Recent supplier troubles have led ratings agencies such as S&P to downgrade supplier credit ratings or put some companies on credit watch. A lower credit rating can make borrowing money more expensive.

During the first three months of the year, S&P downgraded the ratings of nine auto suppliers. As of last week, the firm had tagged 18 suppliers with negative outlooks and was taking a cautious approach to what has become a volatile business sector.

"Although 26 auto suppliers have stable outlooks," King said in the S&P report, "many could face ratings pressure if the challenging environment persists or worsens."

You can reach Brett Clanton at (313) 222-2612 or bclanton@detnews.com.