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Automotive Industry

Three distinct performance levels - Suppliers Business - financial survey of original equipment automotive parts suppliers

Automotive Industries, Oct, 2002 by Craig Fitzgerald

It has been widely reported that profits have tanked over the past two years for OEMs and large publicly traded parts suppliers. While it has been speculated that similar declines have infested lower tier suppliers, solid data has not been available to validate this belief due to the "closely held" status of most of these suppliers.

Plante & Moran LLP and the Original Equipment Suppliers Association (OESA) have come to the rescue with a survey profiling the financial performance for lower tier suppliers for the period 1998 to 2002. Some of the findings validate commonly held notions, while others provide new insights into the dynamics of supplier profitability.

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Survey Background

Data was collected and analyzed from 50 lower tier suppliers to answer four key questions. Including:

* Are lower tier parts suppliers earning adequate rates of return to retain investor capital in the business over the long term?

* Are suppliers' capital structures healthy?

* Are there certain business models that are more profitable than others?

* Are suppliers continuing to invest in their businesses?

Key Survey Findings

There are three distinct profit performance levels among suppliers:

* Approximately 20 percent of the suppliers have excellent performance by virtually any profitability, liquidity or leverage measure.

* Approximately two-thirds of the suppliers fall Into the group we describe as "inadequate profitability" suppliers. This group is earning an average operating margin of approximately 4.5 percent of sales, has substantial debt, and is susceptible to perils outside of their control.

* Nearly 15 percent of the suppliers are "negative profitability suppliers." These parts makers have negative cash flow, have slashed capital investment and are struggling to regain profitability and financial stability. For these suppliers, improving profitability and liquidity is an urgentpriority.

Let's now look at some of the more interesting detailed findings and implications from the survey.

Comparative Earnings Performance

Lower tier suppliers have stronger earnings performance than either OEMs or the large publicly traded systems integrators. The table above shows the operating margin performance for three groups.

While the average lower tier supplier outperformed the OEMs and systems integrators, their results are certainly nothing to brag about.

The high-performance supplier group is doing just fine. They are aggressively reinvesting in their businesses, have comparatively low debt and have been steadily growing their bottom line performance over the past several years. The high-performance supplier group's operating margin averaged 13.9 percent of 2001 sales. The mid-performing group, identified as "inadequate-performing suppliers." represents 68 percent of the survey respondents, with operating margin of 4.5 percent of 2001 sales. This represents a decline of nearly 35 percent from their high watermark in 1998. This group was optimistic regarding the future and expected a nice bounce back to a 6.7 percent operating margin in 2002 (which seems optimistic).

Of great concern is the nearly 15 percent of survey respondents that are experiencing substantial operating losses and negative cash flow, averaging a 5.7 percent EBIT loss.

Earnings before interest, taxes and depreciation (EBITDA) have remained relatively stable for the average lower tier supplier during the 1998 through 2001 period, hovering slightly above 10 percent. Capital expenditures have also remained quite stable during this period, varying year to year between 4.75 percent and 5.75 percent of sales. Depreciation and amortization expense has hovered consistently around 4.0 percent of revenues annually. Free cash flow for most lower tier suppliers has been adequate to support continued investing in their businesses between 1998 and 2001.

Capital Structure

The average debt to equity ratio for the P&M/OESA composite lower tier cluster approximated 265 to 1 by 2001. This represents a level of aggregate debt somewhat higher than "comfortable" for many suppliers. Overall, too many lower tier suppliers are thinly capitalized and excessively susceptible to "bumps" such as bad debt write-offs, changing bank credit policies and material cost increases, to name just a few.

Business Models Matter

Our analysis of high performance suppliers resulted in the identification of several major differences between high-performing and average-performing suppliers. Cost of goods sold (COGS) for high-performing suppliers was a full 13 percentage points lower than the average supplier. On the other hand, sales, general and administrative expenses (SG&A) for high-performing suppliers is two points greater than the average.

While many of the high-performance suppliers are efficient operators that have successfully reduced internal operating costs, we believe that much of the differential in cost structure is driven by better revenue economics. These economics relate to the use of strong business models that enjoy durable elements of marketplace differentiation and have specific means and methods that allow the enterprise to retain as profit a significant portion of the value they provide (i.e., value capture). For many of these suppliers, innovation, assembly value-added and new applications of technology simultaneously drive both better revenue and cost economics.

Automotive Industry

Three distinct performance levels - Suppliers Business - financial survey of original equipment automotive parts suppliers

Automotive Industries, Oct, 2002 by Craig Fitzgerald

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