A Bumpy Ride Ahead for Parts Industry

A well-worn saying about the auto industry--”When Detroit sneezes, the Midwest catches a cold”--has taken on renewed currency since last month’s terrorist attacks, as the $200-billion U.S. automotive parts sector braces for an extended stay in the infirmary.

Virtually all suppliers were hammered by the immediate plunge in vehicle sales that lasted about 10 days, subsequent production stoppages at the Detroit-area Big Three auto makers and the gridlock that resulted from heightened security at airports, harbors and U.S. borders with Canada and Mexico.

Some parts makers--through a shrewd mix of alternative transportation, rerouting of shipments and hand-carrying of crucial components onto commercial airline flights--managed to keep shipments flowing smoothly and even reach their financial targets for the tough third quarter.

Faced with delays as long as 24 hours for trucks at the Canada-U.S. border, seat manufacturer Lear Corp. chartered barges to cross the Detroit River so it could keep a steady stream of seats heading to factories in Michigan and beyond.

Delphi Automotive Corp., the world’s largest auto components manufacturer, had shipments in Singapore ready to go through Luxembourg to Alabama, or through Anchorage to Los Angeles, depending on which route opened first. The Troy, Mich.-based company had staffers carry critical parts, such as side air bag sensors and the electronic wafers needed to make them, aboard international flights to get them to their destinations.

But overcoming such logistical difficulties is only part of the challenge facing auto suppliers these days.

Indeed, companies across the Midwest and beyond--from engine builders and tire makers to manufacturers of the smallest mechanical components--are suffering from the same set of symptoms: declines in the economy and consumer spending, fears of a protracted war and the major auto makers’ production cuts, especially at Ford Motor Co., in the third quarter and possibly in months to come.

Just in the last week, Delphi said third-quarter earnings fell 82% and that it will continue a restructuring that calls for plant closings and the loss of 11,500 jobs; components maker Dana Corp. of Toledo, Ohio, announced plans to eliminate 11,250 jobs; and TRW Inc. of Cleveland announced 2,400 job cuts in its automotive parts operations.

“Under our view that the economy is downshifting, with a significant rise in unemployment claims,” Deutsche Banc Alex. Brown has lowered by 10% to more than 70% its estimates of earnings per share at most suppliers, said Kenneth A. Blaschke, the firm’s auto parts analyst.

If North American sales take another hit, he said, No. 1 auto maker General Motors Corp. “may have to step up production cuts in the fourth quarter and into 2002.”

No. 2 Ford cut third-quarter production after the Sept. 11 attacks by a whopping 119,000 vehicles with only two weeks left in the quarter, citing difficulties in getting parts delivered to its factories because of the gridlock.

GM cut production by 10,000 vehicles and DaimlerChrysler’s Chrysler Group cut by 3,000--not crisis levels. Both said they rely more on shipping by freight train, whereas Ford depends heavily on trucks.

“Sales of cars and light trucks fell about 30% in the days after the terrorist attacks,” GM Chief Executive G. Richard Wagoner told the Executive Club of Chicago late last month, citing the consensus of analysts and dealer reports. “The best way we can respond to acts of terrorism on our soil is to keep the economy strong, keep our employees working, our factories humming, our economy growing, our nation thriving.”

Brett Hoselton, auto industry analyst with McDonald Investments in Cleveland, said he is unsure how long that can last.

“The fourth quarter is at best choppy--chopping out production a little here, a little there,” Hoselton said. “I think it will be further-reaching, that we’ll see significant weakening into next year.”

That’s ominous news for the parts industry, which already had to absorb auto production cuts late last year and early this year, as well as relentless pushes from its customers, the big auto makers, for price reductions.

Earlier this year, former GM unit Delphi said it would eliminate 11,500 jobs and close nine plants, and Visteon Corp. said it would trim 2,000 jobs.

Visteon, No. 2 globally behind Delphi, is a Ford spinoff that still derives 80% of its business from its former parent. It was slammed by Ford’s production cutback, which resulted in a third-quarter loss for Visteon of $95 million, or 74 cents a share, versus net income of $48 million, or 37 cents, a year earlier. “Although we’ve been able to hold our forecast until now, there is no way we can contain this level of reduction this late in the quarter,” said Michael Johnston, president of Dearborn, Mich.-based Visteon. “We are taking every action to minimize the impact of this latest cut but cannot accommodate this level of disruption in this time frame.”

Like other suppliers, Visteon is trying to map out a fourth-quarter strategy as it awaits customers’ schedules.

“Things have been getting tougher and tougher all year, even without this,” said Susan F. Skerker, Visteon’s senior vice president for business strategy.

“It’s the abrupt, unanticipated cuts that kill you,” she said, noting that the industry runs on “just-in-time” mode, referring to the manufacturing process in which parts arrive shortly before they are to be used, eliminating costly and space-consuming inventory.

So it is across the industry. Auto makers and suppliers are counting on low inflation, energy prices and interest rates, and unprecedented manufacturer incentives, such as interest-free loans, to prod auto sales and thus demand for parts.

But after Sept. 11 and the U.S. counterattack, the wild card is what consumer confidence will do.

Industry experts say autos are among the most deferrable purchases.

With the U.S. market projected to be down about 4% to 16.7 million units this year and declining further to 15 million to 15.5 million next year, things look grim.

“After more than half a decade of solid earnings growth, [auto parts] industry earnings per share fell by 8% last year,” J.P. Morgan’s David Bradley wrote in a research report after the attacks.

He expects the average earnings per share of the top suppliers plus the Big Three auto makers to plunge 48% this year.

Suppliers that rely heavily on Ford’s business were hit hard. J.P. Morgan reduced its third-quarter earnings estimates for Visteon, for example, by 62%.

Deutsche Banc lowered its quarterly forecast by 79% for Intermet Corp., a manufacturer of iron and aluminum castings that derives 11% of sales from Ford; the supplier recently told workers at its Decatur, Ill., foundry that it is considering closing part of the plant and cutting more than 200 jobs.

Aluminum-wheel manufacturer Superior Industries International Inc. of Van Nuys, metal fabricator Tower Automotive Inc. of Minneapolis and driver-control component maker Dura Automotive Systems Inc., also of Minneapolis, all rely on Ford for at least one-third of sales; all have issued earnings warnings or been downgraded by Wall Street.

“All of our North American auto customers have slowed production to reduce inventories, and many have experienced production interruptions over the past several weeks,” said J. Dwane Baumgardner, chief executive of Donnelly Corp., a Holland, Mich.-based maker of auto mirrors. “This has resulted in reduced sales.”

Lear, of Southfield, Mich., about 27% of whose business is with Ford, warned late last month that the auto maker’s production cut would cost it 17 cents a share in the third quarter, with non-Ford production cuts costing 3 cents a share.

But uncertainty can be a moving target. J.P. Morgan downgraded Lear from “buy” to “market perform,” but Credit Suisse First Boston upgraded Lear and Superior Industries to a “buy” rating from “hold.”

Both Lear and Superior Industries are diversifying their customer bases, attempting to become less reliant on business with North American assemblers.

That is one strategy that is helping the suppliers that have not been left reeling.

BorgWarner Inc. of Chicago, which produces four-wheel-drive systems and components for engines and shifting systems, said it will meet its third-quarter EPS target of 75 cents.

Ford is its largest customer, but BorgWarner has a wide global footprint, with Honda of Japan, Volkswagen of Germany and Hyundai of South Korea its fastest-growing customers.

“BorgWarner has done a very good job in cost structure. They’ve done the best job of anticipating,” analyst Hoselton said. “Back in the last fourth quarter, they saw tougher times ahead and started taking cost out. Others have been more reactive.”

Mirror manufacturer Gentex Corp. of Zeeland, Mich., is gaining more customers worldwide with its self-dimming technology.

Johnson Controls Inc. of Milwaukee, which makes seats and auto interiors, is gaining business among non-North American assemblers, and Canada-based Magna International Inc., which makes a wide variety of internal and external components, has a much higher growth rate than its peer group.

Both Johnson Controls and Magna have low financial leverage--Magna is virtually debt-free--and can hold on to more of their revenue.

So the outlook is not entirely gloomy for the supplier sector, but much depends on events of the coming weeks.

Said Deutsche Banc’s Blaschke: “If we get through the end of the year without another terrorist attack on us, and have a decent Christmas selling season, then the economy will hold.”