Industry in Crisis: Many Automotive Suppliers Still in Turmoil—Survey

A joint study commissioned by Deloitte and IHS Global Insight "Money vs Technology" published yesterday, reveals that the German supplier industry is facing a crucial period heading into 2010. The first signs of an overall recovery pose additional challenges in themselves. The survey canvassed 195 senior-level managers of renowned German suppliers. The results provided an insight into the difficulties of reducing overcapacity while acquiring the credit financing required for new technology developments and investments. Even the slow recovery of demand needs to be financed with new credit. The sector faces significant restructuring, as the adjustment of capacity and strategy will not go without a number of bankruptcies and dissolutions.

"The crisis has had a massive impact on the financial viability of small companies—now they have virtually no liquidity left, because banks are hesitant to hand out credit due to the massively reduced ratings in the sector. They will hardly be able to profit from the beginning recovery, but are virtually threatened by it" forecasts Siegfried Frick, Partner Corporate Finance at Deloitte. "In spite of full order books we are going to see a number of illiquid companies soon—these shaky companies will have to restructure very quickly, strengthen their equity basis, and secure access to liquidity."

About 30% Overcapacity

In the boom of recent years, German suppliers have increased production capacities beyond sustainable levels. According to about half of the respondents, the areas of chassis components and electronic systems are oversupplied by about 30%, similarly in drivetrain components. The most dire view experts have is on interior components—here, overcapacity is estimated as high as 40%. Indeed, 57% of responding companies plan to reduce capacity, and 54% expect a surge of merger and acquisition (M&A) activity from 2011 onwards, which will primarily concern manufacturers of drivetrain components and electronic systems, but also of chassis components and interior parts. Most of the takeovers are expected horizontally: by immediate competitors from the same industry area.

Banks Hinder Restructuring, Alternative Means of Financing Increase

The most significant impediments to the restructuring process are—in the opinion of respondents—the banks. Collectively, banks are restricting access to capital and credit, so that numerous companies simply lack the means for restructuring or the buying-up of a competitor. 87% of respondents feel they are facing increased difficulties acquiring bank financing. Therefore, alternative means of financing are being sought from strategic investors, private equity companies and existing owners and shareholders.

Similarly, financing of ongoing liquidity demands is taking new forms, as traditional credit insurance companies have suffered in the financial crisis. Therefore, businesses are increasingly looking at state guarantees, but 75% of respondents still found them insufficient, which is also a consequence of the reluctance of private banks to get involved. Companies are increasingly seeking alternative means of cash-flow management, such as factoring.

Second Wave of Defaults in 2010?

Up to November 2009, 83 automotive supplier companies had defaulted; this is expected to continue into 2010. A number of companies will be successful in their restructuring and refinancing efforts—and potential buyers are few and far between. "In the course of the sector's restructuring, we expect some more insolvencies. That is tough for those companies, but it appears unavoidable from an industry perspective. That is the only way to contain overcapacities and return to a growth path," explained Siegfried Frick.

At the same time, automotive manufacturers are following a long-term strategy of avoiding overly large concentration of suppliers. Suppliers, on their own behalf, strive to provide tailor-made technical solutions to each manufacturer, in order to avoid interchangeability due to full standardisation. Therefore, a full consolidation of the supplier sector is not expected; instead, defaulting companies are likely to be broken up into several parts which would be bought up by their respective nearest competitors, in order to maintain existing technologies and production facilities.

Market Requires New Technologies

The beginning upturn provides other challenges as well. The OEM market now demands new energy-saving technologies such as lightweight components, energy-saving transmissions, or smaller engines with low fuel consumption. The OEM-side demand for hybrid and electric drivetrains is on a permanent upward path, but still requires massive investment in research and development. At the same time, international competition and cost pressures are rising on mature technologies. According to the study paper, these challenges can only be met through increased co-operation between OEMs and suppliers, such as in the field of research and development. A prime area of focus is the area of electronics, as about 80% of future innovations are expected there.

"Our survey shows increasing demand primarily for new electronic systems, but also for innovative chassis and drivetrain technology. This holds a lot of potential for European suppliers, who have outstanding expertise in these fields. This needs to be developed further in order to improve the market position. Under no circumstances R&D investments should be reduced—otherwise, the market would be wide open for non-automotive electronics," says Christian Müller, Automotive Consultant at IHS Global Insight.

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© 2010 Deloitte & Touche GmbH Wirtschaftsprüfungsgesellschaft/IHS Global Insight