* 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
By Christiaan Hetzner
FRANKFURT, Aug 13 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
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."