4-2009 Automotive Market Outlook
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'Great Recession' Strains the Chain

Dubbed the “Great Recession,” the nation’s economic problems are taking a toll on metal and parts suppliers throughout the automotive supply chain, not just on the Detroit Three.

By Myra Pinkham, Contributing Editor

The crippling effect of the recession on the Detroit Three automakers is well known. Less visible is the struggle facing other players in the automotive supply chain, from Tier 1 and 2 parts manufacturers to the mills and service centers that supply them with steel, aluminum and copper products.

Some experts expect the auto market to hit bottom late this year and then start a painfully slow climb, one that could be made far steeper by bankruptcies among key parts suppliers.

The auto supply chain’s problems began in late 2007 when vehicle production started to decline at the same time that commodity prices were increasing, says Doug Harvey, automotive partner at A.T. Kearney in Chicago. “Then in the third quarter of 2008, the financial crisis hit and the bottom fell out of the auto market, creating a very distressed sector.”

Mark Cornelius, president of Morgan & Co., West Olive, Mich., predicts that North American car and light truck production will fall to 8.57 million units this year. That would be a 32.2 percent drop from the 12.63 million light vehicles produced in 2008, and only slightly more than half of the 16 million produced in 2007.

Likewise, U.S. auto sales continue to decline. While monthly light vehicle sales had been running at an annualized rate of 9.9 million, February sales dipped to a 9.1 million annualized rate. Cornelius expects sales to total 9.8 million in 2009, a 25.6 percent decline from the 13.17 million sold in 2008.

These are levels the North American automotive industry has not seen in over 15 years, says Ronald P. Krupitzer, vice president of automotive applications for the American Iron & Steel Institute in Washington, D.C.

“We are in what could be called the Great Recession, especially in Detroit,” adds George Magliano, director of automotive research for IHS Global Insight in New York.

“This is a big mess,” agrees Joe Druzak, president and chief executive officer of Kreher Steel Co. LLC, Melrose Park, Ill. “We are scrapping almost 13 million units a year while producing only about nine million vehicles. You can’t do that without impacting the whole supply chain. And I don’t see anything spurring U.S. auto sales in the short term. We are likely to have extremely bad levels at least for the balance of the year.”

Worsening the problem is the tight availability of credit, despite efforts by the federal government to add liquidity to the market and help lenders shoulder the risk. Metals analyst Charles Bradford of Bradford Research Inc. in New York says that about 30 percent of people who want to buy cars can’t get the necessary credit.

The credit crunch also has made it more difficult for the automakers themselves to finance their own lease programs, says David Detzel, director of outside sales for the Voss Taylor division of Voss Industries, Taylor, Mich. Troubled Asset Relief Program (TARP) funds recently released by federal officials should provide some relief to domestic automakers’ credit units, however.

The bigger issue facing the automotive market is the all-time low consumer confidence that is inhibiting potential buyers, says John M. McDonald, a spokesman for General Motors Corp.

“When people are concerned about jobs and income, they are reluctant to pull the trigger on big ticket purchases such as cars or homes,” agrees George Pipas, sales analysis manager for Ford Motor Co. “Even if they have good credit, they are pulling in the reins on their spending. The credit situation compounds the problem, which is why it is important to get credit flowing again as part of the solution to economic recovery.”

Ironically, because carmakers have improved the quality of their products so much in the past decade, they have actually contributed to their own woes. “Cars are a terrific value,” says Jay Baron, president of the Center for Automotive Research, Ann Arbor, Mich. “They now last a long time and, therefore, have become more of a discretionary item. With the economy down, people are putting off buying.”

While much of the recent attention has been focused on the struggles of the Detroit Three automakers, there is plenty of pain to go around. “The New Domestics are having a hard time, too. While they aren’t standing in line for money, what is happening isn’t a local phenomenon in the United States. It is a worldwide crisis,” adds Baron.

Clearly, the Detroit Three (and their suppliers) have been hit the hardest. Their sales losses escalated in February, led by GM with a 52.9 percent year-on-year decline, followed by a 50.1 drop at Ford and a 44 percent decline at Chrysler. Japanese-owned Toyota Motor Corp. has unseated GM as the world’s No. 1 automaker.

But the New Domestics also had double-digit declines in February, including a 39.8 percent falloff of North American sales at Toyota, 38 percent at Honda and 37.1 percent at Nissan.

The federal bailout of the Detroit Three has thus far consisted a $17.4 billion bridge loan to GM and Chrysler taken from TARP funds and another $5 billion of financing available to the auto supply base under the newly announced Auto Supplier Support Program. While these funds have not boosted the U.S. auto industry as a whole, they have helped

GM and Chrysler to avoid bankruptcy—at least temporarily. “The bridge loan just enabled us to stay in business while we restructure to become more efficient and align our costs to demand,” GM’s McDonald says.

Some industry observers question the wisdom of such government bailouts. “GM and Chrysler will need additional government assistance to get far enough down the road where restructuring can take hold and production volumes rebound enough to get them in the black,” says Morgan’s Cornelius.

“I think it’s just prolonging the agony,” says Daniel Twarog, president of the North American Die Casting Association, Wheeling, Ill. “I believe at the end of the day one or more automakers will declare bankruptcy.” About 145 die casters have closed their doors since the year 2000, at least eight of which were primarily automotive suppliers, he adds.

Christopher Plummer, managing director of Metal Strategies Inc., West Chester, Pa., calls the odds of either GM or Chrysler getting through the recession without filing for Chapter 11 “slim to none.”

Ford, meanwhile, hopes to get through this tough time without federal money. The automaker began making cutbacks at the first signs of the weakening economy, much earlier than its competitors, Pipas says. “We have executed our plan,” he adds, including plant closures, layoffs, renegotiated labor agreements and accelerated new-product development.

Upon submitting restructuring plans to Congress, Chrysler requested an additional $5 billion of federal funds. GM originally sought an additional $2 billion but withdrew that request in mid-March—even before the Obama administration's Auto Task Force deemed the two automakers’ restructuring proposals inadequate and asked Rick Wagoner, GM’s chief executive, to step down.

On March 30, the U.S. Treasury did agree to provide 60 days of working capital financing to GM as the company undertakes a more accelerated and aggressive restructuring process under new top executive Fritz Henderson. Officials from both companies say they plan to comply with the government’s restructuring demands, which may or may not involve a bankruptcy filing.

"We'd like to address our legacy issue and other issues outside the bankruptcy process. We've already made some inroads, including some concessions with the UAW regarding our health care plan," McDonald says.

Should GM or another major automaker declare bankruptcy, “it would trigger a number of other bankruptcies in the supply chain and would result in the government having to come up with debtor-in-possession financing,” McDonald says. “That is why we and Chrysler asked for a bridge loan, to give us the breathing room to do what we need to do outside of the bankruptcy process. It is an enabler to not just stay in business, but to get restructuring done.”

Ultimately, carmakers need to sell more vehicles. Certainly, some customers would be reluctant to buy from a bankrupt company, McDonald adds.

Even if one of the Detroit Three does file for bankruptcy protection, it won’t change the weak demand for light vehicles, says Douglas Richman, speaking on behalf of the Aluminum Association, Arlington, Va. “But there could be some dislocation in the supply chain, especially for suppliers that are tied only to that automaker.”

Dave Andrea, vice president of industry analysis and economics for the Original Equipment Suppliers Association, Troy, Mich., says that while there is no good economic model on just how an automaker’s bankruptcy would propagate through the supply chain, it would likely have an immediate and negative effect on that company’s unsecured suppliers. “When the negative GM auditor’s report was released in March, there was immediate action at many parts suppliers, including the contemplation of bankruptcy filings,” he says.

“The Tier 1 parts suppliers are actually in a more dire situation than even the Detroit Three,” says Voss Taylor’s Detzel. Several consulting firms, including A.T. Kearney and Detroit’s Grant Thornton LLP, say that large numbers of Tier 1 suppliers—up to 50 percent—could themselves be forced to file for bankruptcy this year. Such a move could be devastating, says Harvey. In the current credit environment, they might not be able to get debtor-in-possession financing and be forced to liquidate.

The bankruptcy of a Tier 1 parts company could have a dramatic effect on car companies and their metals suppliers, Druzak notes. “It depends on who it is and the timing, but it could cause one or more automakers to stop making cars for a prolonged period of time until they are able to secure alternative sourcing.”

Currently, 20 to 30 percent of Tier 1 suppliers are in loan covenant violations, Andrea says. His trade group and the Motor & Equipment Manufacturers Association are proponents of the U.S. Treasury Department’s new Auto Supplier Support Program, which is providing $5 billion in financing to these troubled companies. The program also offers suppliers government-backed guarantees that they will be paid for products that they ship—no matter what happens to the company that buys that part. While there will continue to be stress throughout the auto supply chain, “we believe it will reduce the risk of lending into the auto supplier sector and help prime the credit pump to move the economy forward,” Andrea adds.

While throwing suppliers a lifeline, the supplier support program is not a cure-all, says Harvey. “It certainly will help some critical suppliers to avoid bankruptcy short term, but it isn’t sufficient for them to weather the storm.”

Automotive metals suppliers are also feeling the crunch. While the global automotive supply chain is clearly under extreme pressure, Richman notes, the situation isn’t quite as dire for aluminum suppliers because of their growing market penetration. “With the percent of aluminum in each vehicle going up, though we are still experiencing a decline in demand, it is nowhere near the 35 percent decline that automakers are seeing.” Aluminum shipments to the auto sector have declined in the 20 percent range, he estimates.

Aluminum now accounts for about 8.6 percent of the content of an average U.S. light vehicle, up from 7.8 percent in 2005. The strong but lightweight material is making inroads into a number of automotive applications, including bumpers, body panels, hoods, deck lids, suspension arms and chassis components.

AISI, which represents domestic steel mills, maintains that use of new high-strength-steel alloys is outpacing even aluminum. High-strength steel is the fastest growing material in U.S.-made light vehicles, according to the institute.

Nevertheless, notes Plummer at Metal Strategies, U.S. steelmakers’ direct shipments into the U.S. auto industry have fallen about 40 percent, with integrated mills now operating at just 30 to 50 percent of rated capacity (see chart on page 15).

Given that automotive is such a large market, and more depressed than most sectors, it is responsible for much of the mills’ capacity reductions, Krupitzer says. Recovery for automakers and their mill suppliers is likely to be long and slow. Many observers expect the auto market to see “some evidence of a bottom” in the second half of this year or early in 2010, but conditions will remain difficult most likely for several years, he adds.

In fact, some question whether annual production will ever get back to 16-million-plus light vehicles, though that view may be pessimistic. “It will eventually, but not for a while, not until about 2015,” says Magliano at IHS Global Insight. “I don’t see any reason that production won’t get back to 15 to 17 million vehicles eventually, with current demographics,” agrees Plummer, who notes about two million new drivers enter the market each year.

Even if automakers start producing 16 million vehicles a year again, there may still be a structural change in the market, Detzel says. “More will be produced by the New Domestics, which are mainly located south of the Mason-Dixon line. That will give processors and service centers in the Detroit/Ohio area a much smaller piece of the pie.”

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