A Few of My Favorite Things

Automotive Industries,  Feb, 2001  by David Andrea

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If the Sound of Music took place in Detroit, Rodgers and Hammerstein would have penned, "When my buyer calls. When my schedules are cut. When I'm stretched to 60 days. I think of a few of my favorite things and then I don't feel so bad." Except now all three are happening at the same time, and even the most positive of personalities are being treated for clinical depression. OK, that may be too strong. However, as operating margins are squeezed, unit volumes are reduced and cash flows are constrained, year-over-year and quarter-over-quarter comparisons are ruined -- even if, as GSM forecasts, 2001 North American production volumes will be the third best on record at approximately 1 million units above 1996 levels. It's a volume business, no two ways about it.

So, in this "best of times, worst of times" environment, with an ebbing tide lowering all boats, which suppliers are apt to do better than their peer group? First, let's dust off an old consulting report. Remember A. T. Kearney's June 1999 report, Strategic and Financial Insights on Leaders in the Vehicle Supplier Industry? Focusing on cash flow, it questioned what would happen to a group of suppliers if sales fell by 10 percent, 10 to 20 percent, and greater than 20 percent. Many raised their eyebrows at the time over the relevancy of this study -- after all, we were in a new economy where the business cycle had been repealed and U.S. auto sales had established a new trend line of 17 million units. But this study was a bit ahead of its time for questioning the industry's cost structures and preparedness for an eventual downturn. For the most part, the study was accurate in that in the "safest" category it placed MascoTech and Simpson Industries, two companies that "smart money" recently took private. It also selected UT Automotive, Standard Products and Sommer Allibert as safe, which of course other companies in their due diligence did as well before acquiring them. These annual Kearney surveys show that supplier revenue growth, return on assets, and cash flow are critical to survive this cyclical industry.

Second, in looking at which suppliers may come out on top in the current environment, we developed a valuation graphic that attempts to look at three metrics simultaneously: gross margin (for a buffer against immediate cost concessions when the buyer calls), return on assets (as a proxy of how well a supplier can efficiently handle production cuts), and cash per share (to indicate how well a supplier can weather temporary cash flow disruptions). Those suppliers in the upper quadrant (gross margins greater than 15 percent and returns on assets greater than 4 percent), as of the end of 2000, were indeed receiving the highest price-to-earnings ratios (among their peer group) by the market. The market did not as specifically reward cash per share. Visteon -- with the largest cash reserves -- had a P/E valuation of 3.3 versus 8.5 for Borg-Warner and 5.7 for Delphi. However, the metric appears to help Lear (a P/E of 5.5) and Dana (5.5) while hurting Tower Automotive (3.6) which has a higher gross margin and return on assets.

Focusing on gross margin, ROA and cash as a "few (of suppliers') favorite things" will make 2001 "not feel so bad" (with apologies to Rodgers and Hammerstein).

                       ROA (TTM) Gross Margin Cash/Share P/E
American Axle              7.46%       13.95%      $1.26 2.7
Visteon Corp.              4.04%        7.61%     $10.05 3.3
Federal-Mogul              1.19%       25.49%      $0.79 1.6
Borg-Warner Automotive     4.28%       24.13%      $1.07 8.5
Delphi Automotive          6.07%       15.07%      $1.30 5.7
Donnelly Corp.             4.51%       16.14%      $0.43 5.8
Lear Corp.                 3.45%       10.37%      $1.25 5.5
Tower Automotive           4.06%       15.51%      $0.03 3.6
Dana Corp.                 3.44%        15.1%      $0.97 5.5
Source: Clearstation.com, valuation date
as of Dec. 28, 2000

Chief Economist CSM Worldwide Inc.

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