Issue: Mar 2010


Moodys: Negative outlook for European automotive parts manufacturers in 2010



by Moodys Investor Service

The credit outlook for European automotive parts manufacturers remains negative, says Moody's Investors Service in a new Industry Outlook report. Following a difficult 2009, the rating agency believes that 2010 will be another challenging year for the sector.

"2009 was probably the toughest year for the European automotive industry since World War II," says Rainer Neidnig, a Moody's Assistant Vice President -- Analyst and author of the report. "The supply industry was even hit harder as original equipment manufacturers (OEMs) destocked their inventories well into 2009. As a result, the fall in car production was steeper than the decline in demand, with production volumes falling to their lowest level in 14 years."

In the report, entitled "Pressure Is Abating, But Challenges Prevail For European Automotive Parts Manufacturers", Moody's says that it expects that, as incentive schemes phase out, new car sales in Europe could decline by 15% in 2010 from 2009. "Given that new car sales and car production should realign after the destocking of inventories in 2009, we expect car production volumes to perform better and to decline by only 3% in 2010," Mr. Neidnig adds.

However, Moody's cautions that car production rates could decline in the second half of 2010 after a strong start to the year supported by tailwinds from the scrapping schemes in various European countries. "We see this challenge mitigated to a certain extent by the strong action most suppliers have taken to lower their cost bases," says Mr. Neidnig. "Additionally, as emerging markets such as China are expected to grow further and light vehicle production in the US is forecast to rise, we expect car production volumes globally to grow."

Moody's also believes that cash flow generation will be challenged by a potential swing-back of working capital following the significant release in 2009 and by the need to increase capital expenditures again. In addition, a substantial portion of the restructuring charges taken in 2009 will become cash effective only in 2010. The rating agency also notes that raw material prices have strongly recovered from their lows, and it will be difficult to pass these on to OEMs facing end customers who became accustomed to heavy discounts backed by government incentives.

Moody's believes enough challenges remain to maintain its negative outlook for the sector. "Broad-based improvements in ratings are unlikely in the near term, although downward ratings pressure has abated following the 2009 downgrades," says Mr. Neidnig. Moody's further notes that most rated suppliers shifted their financial priorities towards creditors' interest in 2009. The rating agency cautions that if companies abandon this conservative stance, pressure on ratings could increase.

Moody's negative outlook for the European automotive supply industry expresses the rating agency's view on the likely future direction of fundamental credit conditions in the industry over the next 12 to 18 months. It does not represent a projection of rating upgrades versus downgrades.

Moody's: European Automotive Parts Manufacturers - Pressure Is Abating, But Challenges Prevail

Summary

» As incentive schemes phase out, we expect new car sales in Europe to decline by 15% in 2010 from 2009.

» We expect car production volumes to perform better, but still to decline slightly, by 3% year-on-year, due to a solid first half.

» Original Equipment Manufacturers (OEMs) continue to exert price pressure on their supply base as customers became accustomed to heavy discounts backed by government incentives. In addition, recovering raw material prices could squeeze margins.

» Sizeable restructuring activity and cost-cutting should allow for operating earnings at break-even or better, absent a further material decline in volumes.

» A recovering North American market and further growth in South America and Asia should also mitigate pressure points in the European home market.

» It is unlikely that capex levels can be maintained at the extremely low levels of 2009 and working capital will likely stay flat at best. Hence, free cash flow generation will be extremely difficult for many companies.

» Most rated suppliers shifted their financial priorities towards creditors" interest in 2009. If companies abandon this conservative stance, pressure on ratings could increase.

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