Auto Parts Makers Lose Ground - Tire Review Magazine

Auto Parts Makers Lose Ground

(Akron/Tire Review – Wall Street Journal/Detroit News) Despite breathless anticipation over automaker alliances, stock and bond investors still see much of the U.S. car business as a sputtering jalopy.

Chatter about potential alliances between General Motors Corp. and giant rivals like Nissan Motor Co. or Toyota Motor Corp. has boosted GM’s share price since late last month. Over the same stretch, however, shares of most auto suppliers have lost ground. Meanwhile, bond investors have cast an increasingly jaundiced eye on the parts makers, whose razor-thin profit margins look vulnerable to GM’s market-share slide and an economy that is running out of gas.

The result: For a clearer picture of investor sentiment about the U.S. auto business, look beyond GM to the companies that supply parts and services to the big auto makers.

"GM has benefited from some speculative buying lately, but in general, investors are still very skeptical and you see that in the suppliers," says John Novak, a stock analyst with Morningstar Inc. who rates GM shares as overvalued. The firm has mixed ratings for the various parts makers, but he adds that, "there is a sense that with or without an alliance, they might have farther to fall."

GM shares are up more than 40% since Jan. 1, with much of that coming since the alliance talk surfaced in late June. GM’s long-term bonds also have been buoyed by the news, while the cost of default protection on its debt has come down significantly over the past three weeks – reflecting investors’ views that a tie-up would lower GM’s likelihood of filing for bankruptcy-court protection.

But shares of some companies that sell a large percentage of their parts to GM have fallen hard. American Axle & Manufacturing Holdings Inc. is down 15% since Jan. 1, for example, while shares of Lear Corp. are off 29%. Bonds issued by suppliers have taken a hit, and the cost of default protection on companies including Cooper Tire & Rubber Co., Goodyear Tire & Rubber Co. and ArvinMeritor Inc. has increased in recent months, according to Markit Group Ltd., a data provider.

Some bargain-hunters have dabbled in these stocks and if things look up at all, these could prove to be wise investments. But analysts say that, more likely, shares of these companies will be weighed down by near- and long-term head winds. Today, investors will get an update on the plight of U.S. automakers when Ford Motor Co. reports its second-quarter results. Ford lost nearly $1.2 billion in the first quarter and recently said business conditions have become tougher over the past few months.

GM’s U.S. vehicle sales fell 26% in June from a year earlier, and the company has been losing market share for several years. Weakening economic conditions would make things worse for GM and, in turn, its suppliers, says Deutsche Bank analyst Rod Lache. Companies that rely most heavily on sales to GM include American Axle, Magna International Inc. and Lear, he says. Lache has a "hold" rating on each stock. He doesn’t own the stocks, and his firm has done investment-banking work for Lear but not the other two.

Lache points out that a slowing economy, high gas prices and shrinking disposable income after debt payments are all bad omens. "There are a lot of signs here that the market is going to start slowing down," he says. "Every supplier is going to be affected if the North American market slows."

In recent years GM has pushed down suppliers’ profit margins, leaving them little breathing room. "If we had a recession, a lot of these companies could be Chapter 11 candidates," says David Giroux, a portfolio manager with T. Rowe Price Group who recently dropped the reins as the company’s auto analyst. Giroux doesn’t own shares of auto suppliers in the $8 billion T. Rowe Price Capital Appreciation Fund he co-manages.

Over the long term, there are concerns GM will keep cutting the prices it pays for parts. A three-firm alliance among auto makers, providing more heft for manufacturers to haggle for lower prices, could make that worse – though some suppliers might benefit from higher-volume orders.

Financially, the outlook is already looking bleak for the broader auto sector, which carries high levels of debt. Standard & Poor’s has "junk" credit ratings on the debt of more than 80 percent of the North American auto suppliers and retailers it rates, and more than half of those are in "highly speculative" territory. The majority of companies are also seen facing significant business and financial risks.

"If you squeeze the suppliers a little bit more, there may be even fewer of them left," says Kam Hon, an analyst at Dominion Bond Rating Service in Toronto. "The suppliers don’t produce bad parts, but they are in trouble because they have been squeezed so much by their customers and their unions don’t want to give in – it’s a sheer formula for disaster."

If the situation is that dire, some investors believe it may create an opportunity among parts makers because GM and other giants will start sending more of their orders to larger vendors that are more likely to ride out a downturn. T. Rowe Price’s Giroux points to larger companies with broader product and customer bases like Johnson Controls Inc., BorgWarner Inc., and TRW Automotive Holdings Corp.

"Price might not be the only determinant," of who receives auto makers’ orders if things get as tough as some expect, he says. In that case auto makers will "also need to think about who is going to be here tomorrow."

Some analysts believe that if suppliers are forced to lower their prices further, some publicly held companies may voluntarily file for bankruptcy-court protection in order to resist price cuts.

Since 2002, there have been 11 defaults among U.S. auto suppliers, including four in 2005 and one this year. They included big names such as Delphi Corp., Dana Corp., Tower Automotive Inc. and Collins & Aikman Corp. That list is likely to grow unless the outlook for the auto industry changes drastically, which a GM alliance is unlikely to do.

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