Automotive suppliers: time for more ambition?
By: Colin Whitbread, Thursday, June 17, 2010, AutomotiveWorld.com
The swathe of (generally) impressive supplier financial results for the opening quarter of 2010 is well out of the way. Now the question arises, "where to next?" The next wave of Q2 results, which will break in the July/August period, will undoubtedly deliver a further tide of improving revenues and margins, especially in comparison with the same prior-year period, if not versus Q1 2010. But the more interesting issue is what will happen to financial performance in the longer term, as the cycle experiences a more sustained upturn, hopefully on a global basis.
The question for analysts to ponder is simple: to what extent can the streamlined cost structures that have been so painfully achieved thorough recession-driven restructuring in the last 12-18 months deliver margin growth in a period of sustained recovery? Such margin rebuilding is clearly already underway, in some cases - especially among North America suppliers - to a surprising degree. Lower costs delivered Q1 gross and operating margin returns that seemed a planet away in the same loss-ridden quarter of 2009. Thanks to lower interest charges resulting from pruned debt levels and flattened rates, much of this improvement was seen to drop to the bottom line and earnings per share, in turn leading to share price gains that brought smiles to the faces of brave, early-cycle investors.
As executives emerge blinking into the recovery sunlight, many may (hopefully) start to ponder whether the slowly emerging upcycle is an opportunity to do more than just rebuild margins
Management aspirations and ambitions at suppliers will now surely start to fall into the spotlight as crisis/survival strategies are replaced by those targeted first at consolidation and then growth. As executives emerge blinking into the recovery sunlight, many may (hopefully) start to ponder whether the slowly emerging upcycle is an opportunity to do more than just rebuild margins that were attained in the quarters before sub-prime lending emerged from Wall Street shadows and into the glare of political and media attention. Put more succinctly: can the hard-won cost improvements resulting from recent restructuring be the foundation for a new level of earnings achievement or just an opportunity to re-establish the old order of profitability as seen in the pre-credit crisis days?
Some industry observers are in no doubt that a higher level of ambition is required and that supplier managements should aspire to harnessing improved cost structures to scale loftier margin heights going forward. In a new study, AlixPartners opines that the North American automotive supply industry has already rebounded to the profitability levels of the early 2000s, when production levels were 30% higher. Interestingly, the company adds that in order to maximise what it refers to as "a unique and historic opportunity", suppliers today must employ "smart growth" strategies to "ensure that all the hard work and restructurings of the past year are fully capitalised upon." Putting some numbers to this assertion, AlixPartners suggests: "Smart growth can spell the difference between returns of 9% and returns of 12% or better as industry sales come back. It can also spell the difference between companies being good or becoming great."
It is far too early to seek definitive evidence that supplier executives subscribe to this ambitious philosophy, but there are some tentative signs that, at this stage at least, aspirations may be somewhat more muted. Valeo has recently referred to its 2013 operating margin target of 6-7% as "best in class profitability," but while this level of return is much improved from the company’s recent record, and will reflect a significant recent reduction in the break-even level (€1.1bn in 2009), some may question whether this really is a sufficient ambition as rebounding revenue (estimated by Valeo at 7.5% CAGR through 2013) combines with the lower cost structure. In Valeo’s case, the rising margin is expected to merge with capex discipline and working capital optimisation to drive ROCE through the 30% level, but some may argue that aspirations in a new era of smart growth should be higher.
Recent indications of earnings recovery have been impressive, but it remains to be seen whether supplier managements can maintain the cost discipline forced on them during the recession as the recovery gains momentum.
Faurecia has also recently outlined its strategic and financial aspirations going forward. In this case the company foresees its total revenue through 2014 rising at a CAGR of 12% (8% organic) and an operating margin of 4.0-4.5% in 2012 and 5.0-6.0% in 2014 (-1% in 2009). The fixed cost burden (as a percentage of sales) is forecast to drop from 21.3% in 2009 to 16.0-16.5% in 2014 while ROCE is estimated at 26-30% in 2014. The company’s break-even product revenue point fell to €8.3bn in 2009 from €10.1bn in 2008. Faurecia forecasts 2014 total revenue of €16.5bn, versus €9.3bn in 2009. As in Valeo’s case, Faurecia foresees significant top line growth in the next few years, but the company’s aspirations regarding margin growth might appear to some as modest.
In summary, as demand recovers, the deep and painful restructuring that the supplier sector has recently endured may have delivered an historic opportunity to drive profitability beyond the levels seen for many years - what financial analysts like to refer to as "a structural improvement in earnings power." Recent indications of earnings recovery have been impressive, but it remains to be seen whether supplier managements can maintain the cost discipline forced on them during the recession as the recovery gains momentum. Greater ambition might be a necessary, if not sufficient, condition for this discipline to be maintained.
The opinions expressed here are those of the author and do not necessarily reflect the positions of Automotive World Ltd.
Published on Thursday, June 17, 2010
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