Auto supply recovery takes unforeseen detour

By Soyoung Kim - Analysis

DETROIT (Reuters) - When workers at American Axle & Manufacturing grudgingly approved a cost-cutting contract in May to end a damaging strike, analysts forecast hundreds of millions of dollars in annual savings for the auto supplier.

But then gas prices spiked and U.S. sales of once-popular pickup trucks and SUVs tanked.

The fallout: American Axle (AXL.N) shares have lost two-thirds of their value over the past six weeks, the company's debt has been downgraded, and analysts now see it burning cash into 2009 as its largest customer, General Motors Corp GM.N, slashes production and battles for survival.

The sudden turn in investor sentiment on American Axle underscores the pressure on a fledgling recovery for the auto supply sector. The progress made due to years of restructuring is now being threatened by a collapse in demand for trucks and SUVs that industry planners never saw coming.

GM, Ford Motor Co (F.N) and Chrysler LLC in recent weeks have announced deep cuts in light truck production -- the most profitable segment for automakers and thousands of suppliers for more than a decade.

That raises the risk that more suppliers will be forced to seek bankruptcy protection, consolidate to slash costs and lay off more workers. The loss of work is particularly painful for a sector already squeezed by record commodity prices and pressure from embattled U.S. automakers to cut costs.

"A lot of suppliers have to restructure to cope with unused capacity," said Jim Mallak, former chief financial officer of parts supplier Tower Automotive, which was taken private by Cerberus Capital Management CBS.UL last year.

"Only two years ago, there were 16 million cars built. Now it's just 13 million. They have to lay off more and close facilities more," said Mallak, managing director at restructuring advisory Alvarez & Marsal.

RESTRUCTURING IN JEOPARDY

U.S.-based suppliers lost a combined $10 billion between 2002 and 2007. In that period, Asian suppliers racked up a combined $42 billion profit and European suppliers earned $24 billion, according to restructuring advisory Alix Partners.

The pain is greater for the suppliers most intertwined with the fading fortunes of U.S. automakers, such as American Axle, Delphi Corp (DPHIQ.PK), Lear Corp (LEA.N) and Visteon Corp VC.N.

American Axle relies on GM for nearly 80 percent of its sales, and trucks make up almost 90 percent of its business.

The woes of top parts makers also bode ill for thousands of smaller parts companies known as Tier-2 suppliers. The latest to fall was privately-held Progressive Molded Products Inc. A supplier to the Big Three Detroit automakers. Progressive is slashing 2,000 jobs after filing for bankruptcy on June 20.

"We're extremely underweighted across the autos," said Mirko Mikelic, a portfolio manager at Fifth Third Bank, who said he had no plans to add exposure in the sector.

"At this point, no one is imagining a magical recovery in truck sales," said Mikelic. He owns debt issued by auto sector companies including GM and Ford.

BETTER THAN AUTOMAKERS?

Still, some suppliers that rely less on trucks or offer technologies in areas of rising demand such as fuel efficiency appear to be better positioned to weather the downturn.

Among top analyst picks are Gentex Corp (GNTX.O), which makes auto-dimming rearview mirrors, and Borgwarner (BWA.N), which has 80 percent of its order backlog overseas and could benefit from growing demand for diesel and downsized engines.

Citigroup analyst Itay Michaeli said he preferred suppliers to automakers during the current downturn.

"Suppliers with stronger balance sheets will not only take advantage of opportunistic (mergers), but are likely to capture new business from automakers looking to source to financially stable suppliers," Michaeli said.

Shares of Borgwarner and Gentex are down less than 20 percent this year, while American Axle shares have fallen more than 60 percent.

But even those companies are unlikely to emerge unscathed from the slumping U.S. market and the commodities rally.

The North American auto supply chain is facing up to $13 billion of raw material cost increases in 2008 -- or as much as $900 per vehicle, about a third of which will likely be shouldered by suppliers, Alix Partners estimated.

"The increase is far beyond the ability of suppliers to continue to manage on their own," said Kim Korth, founder and president of auto consulting firm IRN Inc.

(Editing by John Wallace)