“The good news is, restructurings worked, both for automakers and suppliers,” said John Hoffecker, a managing director at AlixPartners and co-lead of the firm’s Enterprise Improvement Practice. “As a result, many companies today are enjoying profitability levels that seemed impossible a year ago and are now shifting into growth mode. However, these same companies face a decision: whether, as industry sales volumes also start to recover, they’re willing to settle for ‘quite good’ returns or whether they want to use this historic, once-in-a-lifetime opportunity to truly remake themselves into lean, flexible profit machines.”
The AlixPartners study shows that from 1995 to 2000 profitability for the North American industry averaged 8.5% to 9.5%, on sales ranging from 15.5 million to 17 million units, before the industry fell into what Hoffecker calls “a lost decade” for returns in the 2000s. Today’s 6% returns, the study notes, are being earned on annualized industry sales of only about 12 million units, signaling a lot of potential upside for the industry. In fact, it shows if the industry rebounds to around 15 million units, average industry profitability will likely come back up to even stronger, late-1990s levels.
“However,” continued Hoffecker, “did companies and their managements and their boards fight so long and so hard to come this far merely to return to profitability levels of the late ‘90s, an era when the industry was saddled with massive excess capacity, high labor costs and staggering debt loads? Is that really shooting for the stars?”
“As companies today think about growth,” he continued, “they should be thinking about ‘smart growth’ – such things as flexing their now-lower cost structures to the max, not adding back so-called ‘variable’ costs that can quickly become fixed costs and taking a closer look at SG&A costs. 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.”
The AlixPartners study also uncovers what could be several bumps along the road in the auto industry’s comeback, starting with what could be less-than-expected sales and a leaner sales mix. The study predicts that the “pull-ahead” effect of heavy automaker incentive spending over the past decade (worth about one full year’s worth of sales), coupled with the persistently high U.S. unemployment figures and other economic and sociological factors, will limit the peak of this cycle’s industry sales, between now and 2015, to 15 million to 16 million units, versus many current industry forecasts of 17 million units or more. In addition, the product mix between now and 2015 is predicted to skew strongly toward smaller vehicles, which historically have been the industry’s least profitable. Meanwhile, the study finds that automakers are planning a whopping 50% increase in new-model introductions in the 2011 and 2012 model years, which will undoubtedly lead to some companies not fulfilling their market-share - and profitability - objectives.
Some of the other findings in the study include:
- The current sales recovery has been driven by fleet sales. Most fleet buyers are now replacing vehicles as economic conditions settle, residuals have sharply returned and maintenance costs grow – General Motors, Ford and Chrysler have all nearly doubled their fleet volumes versus their year-earlier figures.
- Raw-materials costs are up 53% in the past year, and not all cost increases have worked their way through the supply chain. In order to prevent bottlenecks, a number of actions will have to be taken, both in the auto industry and the commodities industry. Steel, in particular, is singled out for volatility, which, the study says, requires suppliers and automakers to establish better risk-management systems.
- The bottom 25% of suppliers (in terms of financials) will continue to face challenging times as 85% of their debt comes due within the next five years – at the same time that America’s multi-industry “wall of maturities” also start to come due, greatly limiting suppliers’ options.
- In a sign that America’s century-long love affair with cars may be waning in the “Internet Age” and with the aging of the Baby Boomers, the study finds that the nation may have permanently passed peaks in two critical metrics: vehicles per capita and miles driven per capita.
- In Europe, where the auto industry has not yet undergone the same level of required restructuring as in North America, the study predicts that the current sales slump in Western Europe will likely continue this year, and that pre-recession sales levels probably won’t return before 2014 or 2015.
- China’s auto suppliers are now the most profitable in the world, and saw their revenue grow 23% in 2009, even as exports declined 7%. (By comparison, exports of Chinese automakers declined by half.) Meanwhile, increased M&A is expected in the supply sector in China, with 75% of supplier executives interviewed recently saying they expect at least some deal activity.
- Despite the challenges of 2009, global M&A activity in the auto industry increased in 2009 by more than 60% versus 2008. However, private-equity players continue to sit on the sidelines having conducted only 17 deals, a decline of over 60% from 2008.
Garry Brown, a managing director in AlixPartners’ automotive practice, said that: “Private equity would be well-served to start taking another look at the auto industry, as the industry is now radically transformed. Since the collapse of equity values at the end of 2008, the market capitalization of auto suppliers has increased by more than $36 billion, resulting in a shareholder return of over 104%. Early returners may find many ‘first-mover advantages’ as the industry rebounds.”
