Investor's Business Daily, March 16th, 2007
American car shoppers are a fickle bunch.
They're worried about gas prices and are loath to buy the largest SUVs. But they haven't embraced hybrids fully either.
At the same time, U.S. automakers are reeling from rising costs and fierce competition from overseas companies. It spells production cuts and layoffs for Detroit's Big Three.
That's that's trouble for the auto and truck component suppliers.
"It's no secret that most of them are in pretty tough financial shape," said Philip Gott, director of automotive consulting with consulting firm Global Insights.
But the group is showing some resiliency.
Shares of the 31 stocks in the auto equipment group have climbed 10.8% since the start of the year. The sector climbed to 14 on IBD's ranking of 197 industry groups. It had languished at 137 three months ago.
1. Business
An old saw says what's good for GM is good for the nation. Maybe.
But what's bad for the Big Three is awful for their suppliers.
The Commerce Department said demand for cars, trucks and their parts fell 5% in January. Global Insights said those sales dipped again in February.
The suppliers are in a tight spot. They often are labor-intensive manufacturing operations. But motorists' tastes change fast. Suppliers must be nimble enough to deliver the right new systems to automakers, almost before the manufacturers know they need it.
BorgWarner BWA, the world's biggest maker of automatic transmission parts, is in a skid now, as Ford F, one of its top customers, trims production of its once-popular pickups.
Some are optimistic.
Tenneco TEN hopes tougher emissions standards will help it sell more expensive muffler and emission systems. Consumers' demand for smoother rides and better stability- and traction-control systems holds some promise for its more sophisticated shock absorber systems.
Name of the Game: Stay nimble. Anticipate change.
2. Market
Consumers don't buy drivetrain components or car consoles -- not directly, anyway. Parts suppliers serve the big auto names: General Motors GM, Ford, DaimlerChrysler DCX, Toyota TM and the like.
Superior Industries International SUP relies on Ford and GM for about 85% of sales for its aluminum wheels and underbody parts. Noble International NOBL looks to DaimlerChrysler, Ford and GM to buy most of its steel car body components.
Some suppliers also sell to other equipment makers.
Amerigon ARGN warms the cockles of drivers' hearts by keeping other body parts toasty. It sells its heating and cooling systems to car seat manufacturers such as Johnson Controls JCI and Lear LEA.
Increasingly, foreign automakers are building cars in the U.S. Their orders are picking up, even as U.S. makers scale back.
That's a good thing, because only a few suppliers have much else to fall back on.
Orders for Johnson Controls' car seats and auto interiors dropped off significantly in its first quarter. But a division that sells environmental controls for commercial buildings rallied. Net earnings fell just 2%.
"As a multi-industry company with diverse businesses, we have the ability to withstand short-term downturns in any single business or region," Johnson's chief executive, John Barth, said in an earnings statement.
3. Climate
It has been rough sailing for parts suppliers. More waves are coming.
BorgWarner cut 850 North American jobs in the third quarter. In February it said it will close an Indiana plant, eliminating another 800 jobs.
Consumers' reluctance to buy Ford's once-popular F-series of trucks cuts demand for BorgWarner's transfer cases and other components.
Even a slow housing market plays in. Contractors are major pickup buyers. If they're not building houses, they're not replacing their trucks.
Visteon VC, which makes electronics, cooling systems and other auto parts, also is cutting workers. Losses narrowed last year, to $163 million, from a $270 million loss in 2005. The Ford spinoff hopes to turn its first profit in 2009.
Automakers -- and by extension, the firms that supply their systems and parts -- need to figure out what consumers want and what rules governments will mandate.
Guess wrong, as many American automakers did in pumping out larger and larger vehicles, and car lots fill up with unsold inventory.
"We have an industry that can ill-afford to make any more bad mistakes," Gott said.
Some suppliers are either in bankruptcy or near it, analysts say. A prolonged U.S. industry slump won't help.
There's potential for consolidation.
In December, Toronto-based Martinrea International 5MRE finished its $275 million takeover of the U.S. body and chassis operations of ThyssenKrupp Budd. Analysts expect double-digit earnings gains for it in fiscal 2006 and 2007.
Rising fuel standards, meanwhile, can both hurt and help.
Congress may take up a Bush administration proposal that would require automakers to raise fuel economy standards by 4%. Such a move would cost the industry $114billion through 2017, the White House estimates, with Detroit shouldering most of that -- about $85 billion.
New rules could hit large suppliers such as BorgWarner, Lear and Magna International MGA -- all make key components for Detroit's pickups and SUVs.
But BorgWarner also has technologies that help automakers improve fuel efficiency and control emissions.
Those technologies, and its diverse customer base, "can help the company weather very difficult conditions in its traditional North American market," Credit Suisse analyst Christopher Ceraso wrote in a research note.
4. Technology
Features and technologies are what sets each apart. Automakers are looking for better traction-control systems, lighter alloys and stronger welds.
In the end though, suppliers can only sell it to an automaker if that company can persuade consumers to ante up.
Most drivers will pay more for antilock brakes. Traction control systems are a tougher sell. And the most advanced electronic stability systems draw blank stares.
"The things that get further away from consumer comprehension get harder and harder to sell. And they're a little bit more expensive," Global Insight's Gott said. "So suppliers have a tough time getting payback for their technology. If it doesn't show up in the test drive, the consumer is much less likely to check the box and spend the money there."
Then there's still the open question of what will propel sales in the coming years.
Despite the buzz around hybrids, Global Insights thinks there's consumer pushback. Many drivers don't see enough fuel savings to make up for the high price tag.
Carmakers in Europe and elsewhere have a head start on diesel engines. They're typically more efficient, but U.S. automakers and their suppliers have been slow to invest before they know whether they can pass the most stringent emissions standards in states such as California.
Others believe natural gas or hydrogen might be the answer.
Westport Innovations 5WPT works to allow diesel engines to run on cleaner natural gas. Dynetek 5DNK makes natural gas and hydrogen storage tanks for cars, trucks and buses.
5. Outlook
Despite its challenges, analysts haven't given up on the group.
Consolidation could brighten the picture. Some companies have areas of strength.
BorgWarner has yet to reap the efficiencies of its recent acquisition. Despite the sluggish sales of its four-wheel-drive components, analysts think BorgWarner has fuel-efficiency and emissions-control technology to tout.
Johnson Controls, meanwhile, manages to avoid the worst of the pain from Detroit. The domestic manufacturers account for about 15% of revenue. Its diverse customer base may help in a downturn.
In tough times, innovation is as important as ever. Suppliers with the best technology stand out.
Gentex GNTX, for instance, makes mirrors that automatically darken at night to reduce the blinding glare from a trailing car's headlights. The firm's adding features and getting those mirrors into more makes and models.
"Even though we've been negative on the group, there are a handful of companies we like," said Robert W. Baird analyst David Leiker.
Upside: Rising fuel economy standards could get expensive. But it also means opportunity for suppliers that can help make a car go farther on less fuel.
Risks: Most of the North American parts suppliers are tied closely to the fortunes of Detroit. The suppliers either must diversify their customer base, or hope the Big Three can find the right products to lure customers back into showrooms.
Copyright 2007 Investor's Business Daily, Inc.
