* Parts makers have been adjusting costs to demand for years
* Large "Tier One" suppliers enjoy diversified sales base
* Smaller suppliers at risk, dependent on banks for loans
* Tyre producers seen as defensive due to pricing power
FRANKFURT, Aug 13 (Reuters) - Investing in Europe's auto industry seems like a poor idea these days, but look beyond the headline struggles of mass market car makers and things are looking up for those firms' big suppliers.
A less visible target for nationalist political pressures than their car-making customers, the freer hand that has given them to fire workers, shut plants and move production offshore has let tyre makers like Continental and Michelin and parts suppliers like Faurecia and Valeo protect profits in the slump.
While the mass of smaller industry suppliers struggle with fewer options and banks crunching their credit, the big "Tier One" automotive supply firms are doing well, with tyremakers also buoyed by falling rubber prices and the ability to go on charging consumer customers high prices for replacement tyres.
In France, contrast between carmakers and suppliers stands out. Peugeot and Renault, their historic names and factory towns wrapped up in the nation's sense of its industrial power each took 3 billion euros ($3.65 billion) in state loans to keep jobs in France as global crisis bit in 2009.
Taking a helping hand from the government is now coming back to haunt them, though, as orders remain depressed while costs are stubbornly high. Unlike them, French suppliers Faurecia and Valeo, were left to fend for themselves. They shed staff and closed factories. But now that pain is turning into gain.
"The supplier industry has already adjusted its capacity and fixed cost base severely during the 2008 and 2009 crisis," Faurecia Chief Executive Yann Delabriere told Reuters in mid-July. "Faurecia itself has adjusted its fixed cost base by more than 20 percent globally during that period."
Arthur Maher, European production forecaster for analysts LMC automotive, said: "The component industry is running a much tighter ship - it's just taken as a given when they close a factory in western Europe and open one up in eastern Europe."
"There's less political sensitivity to that then there is in Fiat shuttering a plant in Italy for example," he added, noting that carmakers' willingness to switch suppliers has also forced parts makers to remain competitively nimble.
Suppliers tend to have smaller production plants with fewer employees at each compared to carmakers, making it easier to shut a few without hitting political resistance.
"Most of these businesses can typically take out costs up to about 20 percent of their volume shortfalls," said John Leech, UK automotive head at consultant KPMG.
Even if first-half profits have been down at some suppliers, many are still comfortably in the black at a time when Ford , Opel, Peugeot and Fiat are each losing hundreds of millions of euros in Europe so far this year.
Germany's Continental raised its full-year sales and profit targets on Aug. 2 after forecasting annual global industry production would rise 4 percent this year to 79 million vehicles and raw material costs would ease. Its second-quarter underlying earnings topped even the most bullish forecasts thanks to a 40-percent profit surge at its tyre division.
Investors seeking safer havens are also attracted by the diverse customer base and wide geographic sales footprint that these big suppliers offer. Such firms have taken advantage of better times for some carmakers, especially premium brands, while limiting exposure to struggling, mass-selling marques.
Faurecia may be owned by Peugeot, but profitable Volkswagen is its biggest customer. Add in its sales to BMW and Daimler, and the French supplier generated 39 percent of its global sales in the first half from healthy German carmakers.
Its compatriot Valeo is little different. Growing business with Asian carmakers helped boost its first-half product revenue by 13.5 percent - twice Faurecia's comparable rate. France's ailing carmakers accounted only for 19 percent of Valeo's turnover, as opposed to 23 percent a year ago.
Tyremakers have some even better news. They can look forward to a 20-percent decline on average in natural rubber prices this year. And steady demand for replacement tyres from domestic motorists makes it a much more lucrative business than selling to carmakers determined to squeeze down their own costs.
"I'm interested in a company's cashflow and what their net liquidity position looks like on the balance sheet," said fund manager Stefan Bauknecht, who is responsible for auto stocks at Deutsche Bank's German retail fund unit DWS.
"From a top-down perspective, the best investments in the industry are tyremakers followed by premium carmakers, generally speaking. After that come the broader supplier universe and lastly mass-market carmakers in that order."
Those preferences are reflected in market valuations. Continental trades at 7.8 times expected earnings, with Michelin at 6.6 times and both generated cash last year, according to Thomson Reuters data.
BMW trades at 7.7 times while Renault, which burned 1.3 billion euros of cash last year, trades down at 4.1 times.
A high degree of industry consolidation also gives tyremakers an edge; there are only three major global producers - Bridgestone, Goodyear and Michelin - with Continental and Pirelli well behind in sales.
"Since they operate in an oligopoly, tyremakers are strong enough that they can more or less dictate prices, particularly in the replacement market," said Fairesearch auto analyst Hans-Peter Wodniok.
Nonetheless, investors tempted to look further down the value chain at suppliers of commodity parts will find many of them heavily dependent on their home markets and often in much weaker positions than big manufacturers of sophisticated systems for major car makers, such as anti-rollover brakes.
"Most of the Tier One suppliers are global organisations that have diversified their footprint and are able to weather these shocks," said Leech at KPMG. "The greater risk is those Tier Twos and Tier Threes, such as those in France who never really expanded much beyond their national borders."
Since the automotive supply market is so diverse, Union Investment fund manager Michael Muders says it is important to pick and choose rather than invest across the board: "You really have to differentiate," he said.
"We don't see a turnaround in the car market in the foreseeable future," he said of European sales. "So we're invested in tyremakers that are considerably less cyclical thanks to the replacement market and generate steady, reliable cashflows thanks to their strong pricing power."
Fairesearch's Wodniok prefers pure-play tyremakers like Michelin. But even a diversified component maker like Valeo is, he says, a much better bet these days than any end-product carmaker in the south of Europe:
Of such struggling vehicle manufacturers, he said: "The least attractive supplier is still a better investment."
Explaining a standing "sell" rating for Peugeot, Fiat and Renault, Wodniok added: "Every company dependent on Europe that manufactures mass and not class has a big problem."