Leap of faith

Auto partmakers are flying high… can it last?

Comments Off November 13, 2012 at 9:15 pm by

There’s no doubt, for manufacturers of consumer goods, especially durables like autos, it’s been an uncertain year. Fears over the European debt crisis, combined with uncertainty over oil supply due to ongoing issues in the Middle East, have tempered the outlook for what in an ordinary economy would be clear sailing. All three of the Detroit automakers are profitable, and post-tsunami production is still ramping up from the Japanese firms. European brands continue to build and assemble in North America, further diversifying markets for Tier One’s and Two’s. Why the pessimism?

Automakers are moving forward with excellent vehicle sales numbers. According to Scotiabank automotive analyst Carlos Gomes, September was an excellent sales month, pointing to continued strength in the sector. Sales were up six percent year over year with an annualized production from this time last year at 1.67 million units. This September was second only to the peak year of 2000 in sales. Gomes reports, “imported brands led the way, with volumes surging 12 percent year over year and setting a record for the month of September. European automakers posted the strongest gain, with volumes advancing 15 percent.” Perhaps surprisingly, United States sales are also rebounding, up 13 percent year over year in September, boosting the annualized production total to 14.8 million units, up from an average of 14.2 million for the previous three months.

Gomes notes that economic gloom isn’t slowing new vehicle demand: “The September results were the best in five years and highlight the importance of pent-up demand, as households are opting to replace their aging vehicles even when faced with a sluggish labour market and negative headlines pointing to slowing global economic growth.”

Vehicle sales strong

The Scotiabank study further notes that smaller, more fuel efficient models are finally taking hold in the U.S. market. GM volume, for example, increased only 1.5 percent year over year, yet sales of their mini, small and compact cars surged 97 percent for the same time period.

Even in a recession, eventually vehicles must be replaced, but there are macroeconomic factors in play that could dampen new vehicle demand in 2013. In Canada, the outlook is stable, with modest growth. According to the Conference Board of Canada, real GDP for 2012 will total 2.3 percent, down slightly from the 2.5 percent logged last year. The combination of fiscal restraint, public sector job cuts and slowing fundamentals are predicted to result in an employment growth figure of just 1.2 percent, while real disposable income will ledge up slightly, at 1.7 percent, despite low inflation. Those record low interest rates, however, are fuel for new vehicle sales, and the Board predicts 5 percent more real spending on vehicles and parts in Canada for 2012 and 3.2 percent in 2013, resulting in pre-recession sales levels.

Demographics are also playing a part. According to Statistics Canada, the proportion of Canadians 65 years and over will increase substantially, not slowing down until sometime between 2036 and 2056. That’s a long time off, but the incremental change each year means that the industry may be winning sales from a consumer body in their peak middle age earning years. Either side of this income bulge are populations who buy fewer, cheaper vehicles. Urbanization is also a factor. This global demographic trend will increase passenger traffic, with intra-urban travel in large metropolitan areas topping the list of transportation challenges.

Current population growth is stable at just over 1 percent per year, with most of that growth occurring in cities. An ageing population living in congested urban areas may put pressure on new vehicle sales, unless offset by immigration or a policy change that favours larger families. Even if the urbanization trend reverses, an aging population will drive less, primarily due to disability. Stats Canada reports that 1.7 million seniors (43.4%) report having a disability, with mobility, hearing and vision impairments being the most prevalent; this increases to 53.3% for persons 75 and over.

A possible response may be increased levels of driver automation, leading eventually to self-driving cars. Nissan, for example, has revealed remote parking and steer-by-wire technology and Google is actively testing self-driving technology on public roads in the U.S. The impact should be neutral to slightly positive for metal cutting OEM’s with new actuator systems offsetting weight reduction in manual systems like steering column assemblies.

Mergers wait for Europe

In the meantime, partmakers are taking advantage of a resurgent Detroit Three and post-tsunami production ramp up by Japanese automakers. The economy is volatile, however, and one result is a trend to strong cash postions for many companies on both sides of the border. This, combined with historically low interest rates, makes merger and aquisition a viable alternative to expansion for growing partmakers, especially larger Tier Ones.

PriceWaterHouse Coopers tracks automotive industry merger and acquisition (M&A) activity globally and according to their research, M&A transaction slowed during the first half of 2012, with 264 deals closed with a disclosed value of $10.6 billion, a significant decline compared to the same period in 2011, which totaled 303 completed deals with a disclosed valued at $18.8 billion. The reason is Europe. “Europe is taking a toll on global M&A deal activity,” declares Paul Elie, U.S. automotive transaction services leader for PwC. “Historically, Europe has been among the most active regions in automotive M&A. That said, opportunities exist for automotive companies from emerging countries like China and India to acquire technology or market access at favourable valuations in Europe.”

The economic crisis there is directly suppressing vehicle sales, with new car registrations declining by 6.3 percent through the first half of the year. PwC’s expects 2012 annual sales for Europe to decline by 7.3 percent to 12.6 million units, nearly 3.4 million units below the 2007 peak. One result is that the region is now carrying almost 5.8 million units of excess light vehicle manufacturing capacity. While this is bad news for exports, it does offer some tempting targets for mergers and acquisitions for at least the next 12 months.

The real action is in Asia, mostly intra-regionally, with 86 out of 98 transactions between Asian companies. Bigger Asian partmakers are not just looking for economies of scale; these buyers are also likely to pursue technology deals to compete globally, as well as to defend against foreign competition. Canadian partmakers looking to crack Asian markets will need size, technology, or both to address the current trade imbalance in parts.

According to Elie, “ PwC maintains positive expectations for deal activity contingent upon the following conditions: Successful resolution of Europe’s sovereign debt crisis; Strong economic recovery in developed markets such as the United States and Japan; and resumption of trend line economic growth in emerging markets like China and India.”

Labour costs: under control

For the majority of Canadian suppliers, however, the Detroit Three and import North American assembly operation are still the primary markets and compared to even a year ago, the traditional “domestic” OEM’s are poised for stable growth. A major factor in Canada is the willingness of the Canadian Auto Workers Union to address labour cost issues exacerbated by the strong Canadian dollar. Recent deals with GM and especially Ford (who claimed a $15 an hour labour cost disadvantage versus the U.S.) will lower the automakers labour costs significantly, with the deals also obliging the automakers to maintain production in Canada, a win-win. Almost as importantly, the CAW’s pattern negotiation strategy means that the Detriot Three are at the beginning of the contract cycle more or less simultaneously, assuring labour stability for several years going forward, a major factor when OEM’s decide on allocation of production capacity.

The labour cost issue is one counterattack against a strong dollar, but as an industrial nation, Canada is still not addressing the longer term issues that threaten our position as both vehicle makers and part suppliers. The traditional explanation for lagging growth and productivity in both partmaking and the manufacturing sector as a whole has been economies of scale, or more specifically, our lack of scale as a small-population nation. A damning report from Deloitte entitled “The Future of Productivity: Clear choices for a competitive Canada” – makes it clear that Canadian companies need to be bolder when it comes to investing in productivity-boosting measures and seeking out growth, both within Canada and internationally. “Canada’s productivity performance has been declining for many years, in part because Canadians appear to be more concerned about protecting and preserving what they have rather than creating something new,” said Frank Vettese, Managing Partner and Chief Executive of Deloitte Canada. “Trying to maintain the status quo in an environment of increased global competition will simply leave us falling further behind other countries.”

Canada: still lagging

The Deloitte report found that Canada’s productivity lags the United States in virtually every category, regardless of a company’s size, sector, business type or location. The gap in competitiveness has been particularly significant in the manufacturing sector where, since 2000, U.S. productivity has grown six times faster than in Canada. “Canadians know how to compete and win globally, but not enough of our business leaders follow this path,” said Bill Currie, Deloitte Canada’s Vice Chair and Americas Managing Director, who co-authored the report. “They need to exploit growth opportunities wherever they occur, and government needs to support them by making growth a business imperative and removing barriers to competition, both inside Canada and with the rest of the world.”

The report makes sobering reading. Exporting firms outperform their non-exporting peers in terms of productivity growth, but fewer than three per cent of Canadian firms export. Canadian businesses spend at only 65.2% the U.S. rate on machinery and equipment and manufacturing investment in information and communication technology is at 66% of U.S. levels. In the face of low foreign investment levels in the sector, government still maintains a ponderous and expensive foreign direct investment review process, insulating Canadian businesses from direct competition and reducing the incentive to invest and innovate in order to remain competitive.

In a recent speech to the Vancouver Island Economic Summit, Bank of Canada governor Mark Carney clearly voiced frustration over Canada’s lagging industrial performance: “We are in an environment where we have a strong currency, imported manufacturing equipment is cheaper than it ever was, we have fierce competition internationally, we have a productivity deficit versus virtually every other advanced economy—our productivity is 70 per cent of the U.S.—and we have massive opportunities. Should we just wait out a decade-long deleveraging process in the crisis economies? Should we lower our expectations? Or should we control our destiny by building on our strengths in the new global environment?”

While the answer seems self-evident, fear and timidity can’t be analyzed by statistics … yet they may be the biggest single determinant in national success, both in the automotive manufacturing sector and for the Canadian economy as a whole.


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Jim Anderton

Jim Anderton

Jim Anderton is Editor, Canadian Metalworking Magazine

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