DETROIT, Mich. and NEW YORK, N.Y. — More than 40 percent of China’s auto suppliers surveyed by global advisory firm AlixPartners are facing severe liquidity issues in 2009, and research of the overall industry shows that several of China’s suppliers may fail in the next 12 to 18 months, unless they implement aggressive cash-conservation measures.
The annual study, the 2009 AlixPartners China Auto-Suppliers Outlook, analyzed data gathered from in-depth interviews with 40 senior executives from both foreign and domestic players in China’s auto-supply sector and coupled that with extensive research of the industry in China.
According to the firm’s research, China’s auto suppliers were both unprepared for, and slow to react to, the dramatic automotive slowdown both domestically and globally last year. In a similar survey in China by AlixPartners one year ago, 55 percent of suppliers expected to see more than 20 percent revenue growth in the 2008-2010 timeframe, along with healthy profit margins, compared with the 40 percent now saying they face severe liquidity (the cash needed to sustain normal business activities) problems due to the downturn. By the same token, more than 20 percent in this year’s survey said they endured net losses in 2008 and, for 2009, more than 50 percent said they expect to see net profit margins of below 5 percent — while in AlixPartners’ 2008 survey, none of the respondents expected net profits to be below 5 percent this year.
"With external financing difficult to come by, and 2009 likely to be another year of margin compression and slower growth rates, China’s auto suppliers need to radically improve their cash management to generate sufficient liquidity," said Ivo Naumann, a managing director of AlixPartners and head of the firm’s Shanghai office. "The days of both easy credit and relatively easy cash-flow generation are long gone in the Chinese auto-supply market. Going forward, the winners in this market will be those that maximize all areas of cash management, starting with working-capital and operational improvement."
Research from the AlixPartners study revealed that China’s suppliers now have working-capital requirements more than double the level of their global peers due to inefficiencies both in their supply chains and their business operations. Average working-capital requirements for Chinese suppliers in the fourth quarter of 2008 were 74 days (in terms of average sales revenue), compared with 37 days for EU and U.S. suppliers. The research also showed that in terms of profitability, Chinese suppliers today are performing significantly worse than most of their global counterparts, with only U.S. suppliers enduring lower average profit margins.
Total revenue for China’s auto-supplier sector was RMB928 billion in 2008, with 23 percent of that coming from exports. Historically, a quarter of total export revenue came from the U.S., but in 2008 that amount declined 10 percent — and 60 percent of respondents in the AlixPartners survey said they see decreasing export demand as the key challenge going forward as well, and that they are likely to look more to their domestic market for potential growth.
The study also found that M&A activity, both domestic and international, in the supply sector in the past year has also been slower than many anticipated, and that only a few overseas deals have been completed. Surveyed executives’ comments indicate that this is in part due to the near-collapse of many key overseas markets and uncertainties around the viability of potential acquisition targets, coupled with the difficulties in managing distressed assets overseas.
Nevertheless, M&A opportunities remain high on the agenda of supplier executives. Forty percent of suppliers interviewed said they are right now looking at domestic deals, and 25 percent said they are looking globally.
Said Naumann: "With markets and valuations likely beginning to reach bottom, plus with growing competitive pressure inside the Chinese market, we expect to see significantly more M&A activity both in and outside of China going forward. On the other hand, though, a number of executives surveyed mentioned their intent to use this market downturn to recruit talent, both locally and from abroad, to grow organically. Clearly, no matter what happens on the M&A front, suppliers are under pressure to optimize their internal capabilities and efficiencies. This is a paradigm-shift for many companies, and one that many are struggling with to implement effectively."
One area of opportunity for suppliers, the study found, is in the aftermarket (sales of parts to retailers and the general public), which is generally more profitable to suppliers than are sales to automakers. About 60 percent of supplier executives interviewed are expecting revenue growth in this segment this year, compensating, in part, for their loss of original equipment export business of late. The aftermarket in China is expected to represent 19 percent of the auto suppliers’ market share by revenue by 2013, they said.
Taking advantage of opportunities in the aftermarket, however, requires a shift in business model, which might prove a challenge to many suppliers, according to the study. "Driven by the fast-maturing vehicle population in China and the higher profitability expected in the aftermarket, many suppliers are planning to expand aggressively into this segment," said AlixPartners’ Christian Paul, a director in the Shanghai office, "but being successful requires a very different skill-set, new distribution channels and new sales tactics. According to our research plus our work in the field, a number of companies simply lack the appropriate management experience and, therefore, will probably find it difficult to succeed."
"This will be a year of rapid change in China’s auto-supply industry," said Naumann, "with some companies failing to manage liquidity and struggling to restructure internally, while others take advantage of this environment to transform themselves into even stronger players. The difference between the two will be not only having the right strategy but also having the right execution."