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Auto Parts Makers Replacing The Big Three

Posted: Sep 03, 2007 12:04 PM by Dean Lundell

Tickers in this Article: DCX, F, GM, VC, ARM, AXL

Times are tough in the auto and truck parts business. Dependence on Detroit's Big Three used to be an advantage. The bog companies prospered and so did the companies connected to them. However, as the big three have struggled so have the companies who relied on them. We're going to examine three companies who are trapped in this rut. Each firm is taking steps to restore revenue and profitability now, but the road ahead is long and bumpy.

Too Dependent on GM & DAI
American Axle & Manufacturing (NYSE:AXL) became an independent entity in 1994 when General Motors (NYSE:GM) sold its money-losing axle business. With a market capitalization approaching $1.2 billion and sales of $3.2 billion, it is doing better but is still far too dependent on GM and the Chrysler Group (NYSE:DAI), which together account for almost 90% of AXL's revenue.

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American Axle is doing everything one can expect - moving jobs to more cost effective countries, restructuring and closing plants domestically and seeking alternative customers outside North America. The company is making some progress in that endeavor as evidenced by its recent agreement with the Asian company Cherry to supply rear-wheel-drive modules.

The parts manufacturer has the financial flexibility to respond to the market with about $330 million in cash and a $500 million revolving credit agreement. The firm's revenue is not only overly dependent on GM and DCX, but is growing in the wrong direction. Revenue growth has averaged 0.5% per year for five years, -4.7% for the last three and a -5.8% last year. There are no profits because American Axle's gross margin of -2.6% expands to a -6.3% net margin and a -23.6% return on equity.

Defensive Focus
ArvinMeritor (NYSE:ARM) was formed seven years ago when Arvin Industries and Meritor Automotive merged. The combination boasts a market cap of just over $1.2 billion and sales over $9.2 billion. The good news about ArvinMeritor is that it is expanding its horizons and reduced its dependence on the Big Three to about 25% of revenue. The firm recently entered into a contract to supply the U.S. Army with a mine-resistant and ambush-protected personal carrier.

This new military vehicle is potentially a very big deal. Other customers could include the Marine Corps and other NATO countries. The technology could also be transferred to a number of other military applications. Meanwhile ARM is looking at and implementing the usual easy answers of closing plants and exporting the jobs to developing countries.

All these measures had better work because ArvinMeritor could use some help. Aside from its $400 million pension liability, its revenue growth is headed in the wrong direction as well, averaging 6.2% for the last five years, 5.7% over the prior three and 3.3% last year. There are no profits and ARM's 6.3% gross margin works down to a -4.7% net margin and a -52.4% return on equity.

Cut The Apron Strings
In a similar fashion to GM and AXL, Visteon (NYSE:VC) was formed seven years ago when Ford (NYSE:F) spun off its parts-making operations. With 50,000 people in its employ and just over $11.4 billion in sales, VC has a market capitalization of $662 million. VC narrowly avoided bankruptcy protection in 2005 when Ford bailed them out. To this day, Ford accounts for about half VC's sales. Visteon is also desperately seeking customers outside North America and hiring new managers. It has implemented a massive restructuring program as VC's accumulated losses since inception amount to about $2 billion.

Visteon's financial results are headed in the wrong direction, too. VC's revenue growth has averaged -8.5% over the last five year, -13.5% for the last three and accelerated to -32.7% last year. Its gross margin of 3.9% turns into -3.8% net margin and there are no earnings and a zero return on equity.

Obstacles and Opportunities
The market-cap-to-revenue ratio of these companies borders on the ridiculous: Ameican Axle, at 0.37, is the best of the lot. ArvinMeritor is at 0.13 and Visteon is at 0.06. Clearly the market is placing its money on American Axle, as its shares have appreciated about 40% in the past year while ArvinMeritor has risen roughly 20% and Visteon has dropped around 40%.

While each of these firms is vulnerable to any downturn in the domestic auto and truck parts business, medium and heavy truck production in Western Europe is seeing solid growth. If these companies can overcome their myopic view of who is and is not a customer, perhaps they can turn this situation around.

For added insight, check out Industry Handbook: The Automobile Industry.

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By Dean Lundell

Dean Lundell is a former vice president at Merrill Lynch Capital Markets, a principal of a regional investment bank, an independent futures trader and licensed commodity trading advisor. He has written for McGraw-Hill, the Chicago Mercantile Exchange and several financial magazines. Prior to his career on Wall Street, he served with the 82nd Airborne Division in Vietnam.

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