Wednesday, 16 April 2008

Macro-Level Trends – US & W. European Contraction – Searching for the Economic Bed-Rock

US and European auto-makers and their suppliers spent much of 2007 (indeed much of the last 5 years) trimming and re-trimming operations to a lean condition to enable the battle against the ever growing headwinds. Labour negotiations and legacy costs have been dealt with, and all too briefly, there was a respite in Q307 with the possibility of profitability increases looking forward into 08.

At that moment, many observers were (to our minds) overly bullish in their projections of a flat US market at 15.5m units for 08. Given the real-world, market-centric effects (even pre-cursing the credit melt-down), investment-auto-motive’s projections were in the realm of a very conservative 14.5m (factoring-in a retail-end credit squeeze), demonstrating what work lay ahead of the US industry to re-balance in what were already testing times. However, although at that point in time we had the unhappy fortune of calling closest ahead of time, all formal forecasters reacted to the unwinding credit-bubble by Dec07, the Jan08 projection by CSM stood at 14.3m – a massive 1.2m units below Q307 mass consensus; and again recently down-graded to 14.1m. And that is with as yet to be fully identified and absorbed write-downs by the banking sector.

There is of course the school of thought that the massive ‘knee-jerk’ pendulum-swing in banking and retail credit-offer terms is infact “pulling the rug from under the feet” of what are legitimate, sound credit-risk consumers, and this in turn is creating the unwelcome spiral effect of reduced consumption; most obviously witnessed in autos.

March YoY figures for the US and Europe are looking dismal, down 8% and 9.5% respectively. In the US, even Toyota and Hyundai, the biggest winners of 2007 have seen the biggest falls of 17% and 15% respectively, thereby putting pressure on domestic aswell as Asian VMs and their supply-bases to re-think their exactly how they can move forward under such harsh domestic conditions. These figures will have major ramifications across the global supply-chain, the Japanese and Koreans demanding more cost-downs from domestic and Chinese parts-makers, whilst the US Big 3 will have to push for greater access to massive volumes of Sino-derived low-value parts.

The reality for much of the Tier 2 and 3 US suppliers is that their world has been changing rapidly throughout the last 5 years, but their own order-book ‘up-turn’ projections (based on economics figures and industry rhetoric) has had to be post-poned time and time again.

This is undoubtedly the period of great industrial ‘unwinding’ in the US. [Perhaps less so for Western Europe who’s supply chain was more consolidated and less reliant upon a massive network of long established, but unfortunately strategically trapped, family businesses]. Of course, given scale and economic impact, the main focus has been upon the Tier 1s, the likes of the Delphi, Dana, Collins & Aikman, Visteon, Tower, Wagon, American Axle etc many of which have been under the protective umbrella of Chapter 11 for a couple of years. That has attracted PE & activist share-holder interest from the likes of Wilbur Ross and Carl Icahn, creating new amalgamated enterprises (ie International Auto Components Group) to cherry pick the best of forced divestments to create a new addition(s) to the US’ big Tier 1 family, And given its name, and origins, they may well be sold-off to cash-rich Asian firms seeking a proper foothold in the US to both feed the Big 3 and ‘New Domestics’ aswell as the expected latter-day introduction transplants from China and India.

Bernard Simon of the FT reports that whilst the big stories (and allied industry conjecture) obviously take centre-stage, there has been a wave of antipathy that has swept the small operators, their proprietors finding that the business case their companies were founded upon decades ago has simply diminished. Too small and too unsophisticated to be of interest to local and international trade buyers, they’ve simply shut-up shop.

Ironically, in the ebb and flow of industrial change, the struggles of certain suppliers such as American Axle’s strikes, are undoubtedly helping automakers themselves to halt the assembly of over-capacity product such as in this GM’s Large Truck & SUVs; helping to reduce the over-stock of factory-held inventory. But of course the strikes themselves are largely related to the manufacturing reduction GM has been forced to undertake and that impact on their supplier-base.

The likes of Magna International, Tennaco and Lear Corp stand in the same firing-line for worker unrest as they will expectantly be hit by scaled back GM orders, now hitting cars like the Cadillac DTS & Buick Lacerne, not just obvious Large Truck assembly.

Quite clearly, the ‘given-ground’ offered by the UAW to the Big 3 set precedents that the US supply-base will simply have to follow. That means new entry-level labour pricing and very probably the VEBA model for pensions and healthcare to buoy company balance sheets and liquidity for a US rebound, itself much dependent upon the weak US Dollar that has assisted cross-sector exports in recent months.

So that downward economic spiral hasn’t quite finished its journey, and the working-man, watching his world apparently fall-down around his ears won’t believe the storm clouds are ready to shift soon. But look at the bigger macro factors, beyond the credit-crunch, and a cost-contained US industrial base married to the weak Dollar and undoubted external/ FDI investor interest from homeland activists, foreign trade-buyers, PE and SWFs should provide the all important foundation for growth.

As far as the currently fragile supplier-base is concerned analysts offer varied opinion on the level of, and speed of, stock and MktCap value creation, but the balance is shifting in favour of a rejuvenated sector over the next 8-12 months, itself tricking into the ‘real economy’ in 12-18 months.

But as ever, forecasting industrial growth and the consumer confidence lag in these - to quote Greenspan’s verb – “turbulent times” isn’t easy. Factor in the growing appreciation of ‘Black Swan’ effects and forecasting will become perhaps even more of a black art than the science it often endeavours to present.