What has been dubbed the "Great Recession" has touched industries and companies large and small. One has to look no further than the automotive sector to see an industry that has been profoundly impacted. In 2009, with the impact of the credit crisis and the significant collapse in vehicle demand and production, we have witnessed two major automakers enter and exit Chapter 11 bankruptcy, over 45 documented automotive supplier bankruptcy filings and an untold number of suppliers that have simply ceased operations and liquidated outside of the bankruptcy process. As we assess the fallout from what has been a tumultuous year for the industry, we also look to what lies ahead for the supply chain.
While the bankruptcies of General Motors and Chrysler backed and funded by the government likely helped forestall a broader collapse that could have further impacted the supply chain and other automakers supported by those suppliers (perhaps the broader economy), there is concern that the market mechanism has not fully eliminated the excess capacity that exists in the system. Despite noteworthy high profile supplier bankruptcies, there were expectations of a broader shakeout among suppliers, particularly at the Tier 2 and 3 levels, that would have allowed for a stronger, more right-sized supply base going forward.
As the market contraction intensified in late 2008, we saw significant resourcing activity on the part of automakers and Tier 1 suppliers. Financially challenged automakers had reached a point where they would no longer prop up weaker suppliers in order to ensure the supply of components. Instead, with production volumes already collapsing and the impact of minor part supply interruptions minimized, they worked to resource key business to other, more stable suppliers. While this certainly proved detrimental to those suppliers losing business, it provided a much-needed opportunity to bolster capacity utilization in a challenging market for suppliers who were awarded the resourced business.
A supplier shakeout of sorts is occurring, but at a slower pace and more often under the radar as smaller companies are simply closing their doors. It is difficult to gauge the actual number of bankruptcies or liquidations given the low profile nature of many of the companies. One may simply see a small mention in the local newspaper of a local tool and die shop or stamping company closure. Automakers and suppliers alike are closely monitoring their downstream supply base for signs of stress and are working to triage the companies to determine current and future sourcing strategies.
As the market moves from the contraction to recovery stage, many companies are finding that managing the upturn is more difficult than weathering the downturn. When companies experienced the downturn in order activity, they were at least able to collect on outstanding receivables generated prior to the contraction, and their own cash requirements were reduced due to the decline in production activity. However, with automakers looking to ramp up production, both to replenish depleted inventories and prepare for a recovery in demand, many suppliers are finding it difficult to secure the necessary raw materials and the crucial working capital required to restart and/or expand production.
While the raw material availability situation has improved as companies bring capacity back online, credit availability remains problematic. Companies of all sizes are finding it difficult to obtain traditional bank financing to provide the needed working capital liquidity and funds for expansion to accommodate new business contracts. As Figure 1 indicates, there is still a general attitude on the part of lenders toward tighter standards for firms requesting commercial and industrial loans. While the percentage of lenders reporting tighter standards has declined from the peak in 4Q 2008, there is still reluctance on the part of the financial community to ramp up lending activities. Furthermore, the Federal Reserve Board Senior Loan Officer Survey does not distinguish among industries. This is a critical point given the anecdotal reports of several traditionally automotive-focused commercial banks looking to substantially reduce their automotive loan exposure.
On the other hand, Private Equity (PE) is showing signs of looking to re-engage the automotive market. Given the challenges still facing the debt markets, the deals themselves will likely be more strategically focused equity plays or perhaps distressed purchases that match well with an existing portfolio company in the near term, rather than the "strip and flip" strategy of not so long ago. Furthermore, as PE treads back into the automotive sector, as previously mentioned, there are concerns about whether we have eliminated enough excess capacity and created the foundation for a healthier and more profitable supply chain. PE is expected to continue to be more cautious in their evaluation of deals, at least in the near term.
One positive byproduct of the dramatic production cutbacks is the fact that many suppliers have intensified cost-cutting efforts and restructured their operations significantly. In fact, a recent survey of suppliers by the Original Equipment Supplier Association (OESA) revealed a median estimated 2010 North American light vehicle production break-even point of 9.5 million units. With CSMas 2010 North American light vehicle production forecast currently standing at 10.5 million units, there is hope that those right-sized suppliers should be able to post some much-needed improvements in financial performance. It will continue to be important to maintain a focus on operational efficiencies and cost containment as the market moves through what can be a volatile period in the early stages of recovery.
The next six to nine months will be critical as we look forward to more sustainable market demand levels later in 2010. A key challenge will be to convince traditional financing providers to re-engage the automotive sector. While the auto sector has received its fair share of criticism, well-earned in many cases, it is a critically important industry that touches virtually everyone in some fashion. These have been challenging times and while there is more work to do (e.g., eliminating remaining overcapacity in certain component sectors, achieving profitability improvements, driving innovation, etc.), brighter days appear on the horizon. This is shaping up to be an interesting and exciting time to be a participant in such a complex industry.
Mike Wall can be reached via e-mail at mikewall@csmauto.com.
