MorrisAnderson

State of the Industry

Opportunities exist, but suppliers and car dealers still struggle.

• Private equity groups have been unsuccessful in securing financing from regular sources – many large lending institutions made a universal decision to avoid the auto industry, but this lending adversity is changing. If sales don’t recover, lenders will continue to be skittish and liquidity will remain scarce. 
• Many U.S. supply sources have dried up, so suppliers with good cash flow have opportunities in many niches.
• Many automakers are weighing the cost of supplier price increases against the costs of re-sourcing – and deciding that they are better off remaining with their current suppliers. Historically, auto manufacturers had the upper hand, but now, suppliers have more power.
• The automotive industry has been largely domestic, because offshore operations pose supply-chain issues in a JIT system. However major component manufacturers are moving the manufacturing of vehicle body components and engines abroad.
• Mass consolidation of tier-2 and tier-3 suppliers is inevitable. The number of small suppliers will be greatly reduced. Tier-1 suppliers are still consolidating and are now more likely to be able to favorably negotiate with “The Big Three.”
• Foreign car companies are generally more concerned about supplier relationships than “The Big Three.” Despite the bankruptcy of GM and Chrysler, supplier relationships are the same old game. 
• In 2004 and 2005, suppliers were crushed by rising commodity costs (such as oil and metal) as most had long-term, price-locked agreements with customers. Now, suppliers demand price-escalation clauses in major contracts involving raw materials. This is a global trend.
• Dealerships are a big part of this puzzle: “The Big Three” closed between 20 and 30 percent of their dealerships as part of bankruptcy filings. Still, more dealerships should have been shuttered to bring dealer sales volume rates back to competitive levels with Japanese brands. State franchise laws complicate matters because dealers are largely protected from contract termination by the automaker.
• To rebuild locations, dealers must focus more on service because new vehicle sales have a very low profit margin. Dealerships make more money on service and used cars.

6- to 12-month Outlook

• The industry will continue to slowly recover. When vehicle build rates recover to 13 million units the auto industry should be back on track. This will take 2 more years.
• Growth will depend directly on car sales; a gradual growth of 10 percent per year (about one million units per year) would be best for “The Big Three” and the U.S. economy. This solid growth is not enough to stress the supplier chains working capital.
• New Asian and European carmakers may have trouble ramping up in the United States in this economy.
• If any major automaker goes out of business, it could destroy enough interrelated suppliers to collapse the entire U.S. auto industry. This would make the auto industry recovery nearly impossible without government intervention.
• Dealers will not have enough service revenues to offset the lack of consumer buying.