Thursday, June 11, 2009

Auto Suppliers. Up on fundamentals or bailout hopes?

AlphaNinja - Auto supplier stocks have been on a TEAR recently - up about 325% since the March 6th low, versus a 39% gain for the S&P500. Leading the way up has been Tenneco Inc.(TEN), up over 1,000% since trading under $1. Also up huge is Lear Corp (LEA), although the recovery in the two share prices are for different reasons. Tenneco is still off 51% from its twelve month high, while Lear is still down 92%.

In Tenneco's most recent conference call, you'll find that management and employees have fought back hard against the massive decline in auto sales.

"lower OE production volumes worldwide and manufacturing fixed cost absorption related to those volume declines, produced a negative $100 million year-over-year EBIT headwind this quarter. EBIT was also negatively impacted by $13 million in currency, but our employees worldwide fought hard to counter these conditions and we were able to offset a little more than half of this negative impact, primarily through lower SGA&E spending, restructuring, operational flexing programs, manufacturing efficiency improvements and customer recoveries."

Even with sales down significantly, Tenneco's gross margin held up extraordinarily well:

"This was our strongest gross margin performance since the second quarter of 2008 and a sequential improvement over the fourth quarter 2008, despite a 20% revenue drop in the last quarter."

Then turn to Lear's conference call, which seemed to be more on the order of "sit back and wait/hope for auto units to pick up. There are restructuring efforts, but not nearly the sense of urgency you get from Tenneco. An interesting quote from Lear's CEO -

"Amid very challenging conditions globally the auto industry is struggling to overcome a sales and production environment that is below replacement levels and not at a sustainable rate."

Not a sustainable rate? I'd venture to suggest that the previous rate of 16million units sold annually in the USA was not a "sustainable" rate, and that we're actually closer to an appropriate run-rate now(8-10million) now than we were 18-24 months ago.

Lear made a voluntary decision to delay an interest payment for 30 days, so it can sort out its "capital" options. On the conference call, the CEO said

"Let me turn now to our capital structure - yesterday we announced an extension of the waiver of covenant defaults through June 30. We recognize that we have to address our debt structure although our liquidity remains strong. We continue to explore alternatives with our lenders and others to restructure our debt outside of bankruptcy. This is our strong preference. "

Strong preference? So comforting. I called Lear's IR department back in mid-May and voiced my concerns about where common stockholders figure in managements' mind, in terms of protecting shareholder value versus other stakeholders. I was essentially told that:

"the management and board's first responsibility is to the shareholder. But when we get in a potentially bad situation, our lawyers tell us that we have to take steps to protect the whole enterprise, including debt holders and employees."

How on EARTH does one attempt to value common stock, when you cannot be sure of the moment when management decides that they have switched from building shareholder value to "protecting the whole enterprise?" You simply can't. For the weaker auto suppliers, the only hcnace of redemtion lies in a bailout, and yesterday we hear from the AP that one is inching closer by the day. I mean why not? Same industry, same unions...

You have to love the simplicity of the quotes. "Golly, there's not any revenue coming in." "Golly, we can't get money from banks." You don't say.

"Automotive parts suppliers plan to seek an additional $8 billion to $10 billion in loan guarantees to help them weather a bleak auto sales environment and the bankruptcy court restructuring of major customers GM and Chrysler. The Original Equipment Suppliers Association and Motor & Equipment Manufacturers Association said they plan to request the federal aid Wednesday from the U.S. Treasury Department to help provide capital to suppliers stung by the declines in the auto industry. But trade association officials say more guarantees are essential for ailing parts suppliers who are facing revenue shortfalls as auto plants are idled or closed. Neil De Koker, president and CEO of the Original Equipment Suppliers Association, said many suppliers can't request money from banks, due to the credit crunch, but have little revenue coming in to support their operations."

My favorite quote:

"The aid will mainly be used to help suppliers pay workers and purchase raw materials. That way, suppliers can quickly resume production once auto plants reopen, said Ann Wilson, senior vice president of government affairs for the Motor & Equipment Manufacturers Association. "The request in is recognition of what's going in the industry right now," she said, "and the need for revenue and capital to be able to start production again."

NO KIDDING. There are hundreds of industries that need "revenue and capital," but don't have the gall to ask for federal subsidies - because they know they wouldn't receive them.

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