Very favorable story in Barrons today suggests that Delphi may be a beneficiary of the big move in Detroit toward internet auctions and supply chain management over the web.
Summary: Big auto-parts suppliers like Delphi could benefit from Internet Auctions. Their own supply chains could be rationalized. Smaller suppliers of commodity items could be crushed under the weight of increased competition in a ruthlessly competitive reverse auction environment. But Delphi has moved away from supplying commodity parts and instead today focuses on such things as multimedia systems and telematics which are expected to grow rapidly in the years ahead.
APRIL 24, 2000 Barrons
Blessing in Disguise?
Big Three's Internet auctions could actually help the top
auto-parts suppliers
By Jacqueline Doherty
When Ford, General Motors and DaimlerChrysler banded together to
form a business-to-business e-commerce site in February, investors started
playing taps for the auto suppliers. Sellers feared that increased competition
from online auctions would cause parts prices to fall, hurting the suppliers'
already-squeezed profitability. But that response might have been
short-sighted. "The suppliers are getting a bum wrap," says Stephen Girsky,
senior auto analyst at Morgan Stanley Dean Witter. "I think the [largest]
suppliers will actually benefit from this."
That's because the biggest players in the parts business don't just manufacture
widgets anymore. Tier 1 suppliers -- those that deal directly with the Big
Three -- have evolved. They no longer make individual components; instead,
they're system integrators, designers and manufacturers. For example, a
company like Lear doesn't just produce seat fabric or springs for customers; it
sells entire seating systems, which might include power adjustments and
heating elements. In addition, Lear works with -- supervises is probably a
better word -- all the smaller companies that supply the parts needed to
assemble the seats. The same could be said for makers of doors or instrument
panels.
Entire component systems, industry observers agree, won't be purchased or
sold through auctions. They're simply too complex. In fact, because such
systems require lots of customization and considerable developmental work
by the Tier 1 supplier, they're usually made under contracts that run three, five
or seven years, to make it worthwhile for the supplier to invest money to
develop them in the first place. In some cases, the contracts even span the life
of the car model. Bidding to manufacture these component systems is already
ferocious among the small group of suppliers that can offer the scale,
reliability, quality and prices the auto makers demand.
"These [large suppliers] are already operating in
an auction environment," notes Kevin Risen,
co-portfolio manager of the Neuberger Berman
Guardian fund, which owns Lear shares. The
World Wide Web may change the method of
communication and speed the process, but it
shouldn't increase the pressures among most of
the already competitive Tier 1 firms.
In fact, the Tier 1 outfits actually may benefit if
they can successfully migrate their own purchases
onto the Internet. Morgan Stanley estimates that
the Tier 1 group includes 1,500 firms; Tier 2, 50,000, and Tier 3, 250,000.
Typically, the further down the chain, the more commodity-like the product a
company manufactures.
Internet auctions will have "the biggest impact on second-tier and lower-level
suppliers making independent parts that are substitutable," says Dean Gulis,
vice president at the Loomis Sayles Small Cap Value fund, which owns
shares of Gentex, a maker of self-dimming mirrors. It's within the ranks of
these small and often private companies that swift consolidation and even
some failures probably will occur.
Tier 1 suppliers already have begun embracing the 'Net. Delphi has
participated in auctions of $500 million in materials since 1998 and reported
saving about $60 million, notes David Garrity, global auto research
coordinator at Dresdner Kleinwort Benson. True, that's a very small part of
the company's overall purchasing budget, but it's expected to grow quickly.
Delphi expects to buy up to $1 billion of materials on the Web during 2000,
he adds, and it has identified about $5 billion of products that could eventually
migrate online. Garrity likes Delphi because of this and because of the
advanced technology the company is developing in several areas.
To some extent, Ford, GM and DaimlerChrysler recognize the power of their
suppliers' purchasing muscle. They're trying to convince the supplier
community to use the Big Three exchange for purchases. However, their most
recent success came earlier this month, when France's Renault and its
Japanese affiliate, Nissan Motor, joined the exchange.
To get the suppliers on board, the manufacturers have said the
business-to-business site initially will focus on items not used directly in any
vehicle, such as paper, uniforms or repair equipment for assembly plants. But
few in the industry think the auctions will be limited to such areas down the
road. It seems inevitable that commodity parts used in a car eventually will be
bought online, at least to some extent.
To make the Big Three site work, the carmakers must quell suppliers' fears
about the exchange's structure. So far, the suppliers seem to want either
equity in the B2B site or at least some type of cash rebate to reward those
doing the most business on the exchange.
Taking to heart the maxim that there's power in
numbers, six large suppliers -- Dana, Delphi,
Eaton, Motorola and TRW in the U.S., and France's Valeo -- are jointly
evaluating the situation, to maximize their negotiating power.
Meanwhile, the Original Equipment Suppliers Association trade group has
started an e-business council and is evaluating setting up its own exchange.
Independently, Dana, which has 8,600 suppliers, already has established an
exchange, through which it expects to save $1 billion over four years.
"There's a major role reversal here. The suppliers are now the customers" of
the Big Three, observes Ronald Tadross, senior auto and auto-parts analyst
at Credit Suisse First Boston. "I think the suppliers want equity and board
representation and if they don't get it, they're willing to play chicken and say
they're willing to form a site of their own."
This shift of power is akin to an earthquake in an industry where Ford and
GM are renowned for browbeating savings out of suppliers.
To make nice with the auto suppliers, the Big Three's exchange must produce
a privacy policy, decide how the profits are split and determine who owns the
data, suggests Thomas Stallkamp, former vice chairman of DaimlerChrysler
and currently vice chairman and CEO of MSX International, which provides
engineering and business advice and specialized staffing services.
That said, Stallkamp believes the focus on profits from auctions is
short-sighted. "We ought to get out of the auction mentality. Moving beyond
auctions is where most of the savings are," he argues. "I see this as a tool to
streamline supply-chain management. It's extremely exciting and could be the
best source of production savings in a long time."
Stallkamp believes the Web should be used for communications throughout
the entire manufacturing process. For although Internet auctions and IPOs of
B2B portals make for splashy headlines, they're only part of a much larger
story. The ability to communicate swiftly with suppliers via the Web is often
overlooked, but it could vastly improve productivity.
Under current procedures, an auto maker sets a manufacturing schedule, and
then tells its Tier 1 suppliers what it hopes to produce that month. In turn, the
Tier 1 outfits inform their own suppliers -- members of the Tier 2 group --
what's in store. Next, the Tier 2 players tell Tier 3 companies, and so on and
so on. It sounds like a bad Breck shampoo commercial, but that's still how
the industry works. Notification may occur via e-mail, fax or phone.
In addition to being time-consuming, this forces each member of the chain to
keep extra inventory. No one wants to be caught short and held responsible
for stopping a customer's assembly line in this just-in-time world.
Consider how much more efficient the process becomes with the Web. The
schedule could be sent simultaneously to every company involved. Everyone's
status could be monitored in real time, and all members of the group would
learn immediately of any changes in the schedule. Transparency would rise,
while the need to hold excess inventory would diminish.
Vehicle designers could reap similar benefits. Right now, it takes about three
years to get a car from concept to showroom. If one part is changed during
development, it can have an impact on many others, causing delays. When the
position of a windshield-wiper fluid reservoir, for example, is moved, it affects
the manufacturer of the reservoir (which might have to change the shape), the
companies that produce parts used to support and secure the reservoir (which
might have to alter their components), the maker of hoses that go into the
reservoir (which might have to make them longer or shorter) and perhaps
even the producer of wiper fluid (who might have to supply more or less,
depending on whether the reservoir's capacity has been changed). A
centralized place to gather information on any design alteration would vastly
speed and smooth the development process.
Even if investors buy the argument that the large suppliers are unlikely to be
crushed by the Big Three's Internet auction plan, they still face a big
uncertainty in deciding whether to buy or hold on to any of the stocks: Is a
slowdown in car sales already priced into the shares or will they collapse if the
sizzling sales pace of the past few years becomes just a memory?
Despite the industry's extremely low prices and price-earnings ratios-the
suppliers carry, on average a P/E of 8 on 2000 earnings, versus the S&P's
24-some investors aren't convinced that now's the time to plunge in. "No one
is going to want to own [auto suppliers] until they think the trough of a
downturn is near," warns Jeffrey Moran, senior research officer at John
Hancock Funds, who doesn't own any of the stocks. Long-term, the Internet
will force suppliers to become more efficient, he continues, "but I'd rather sit
on the sidelines and miss a little bit of the upside and watch how it happens."
Adds Tadross at Credit Suisse First Boston: "Generally, you want to own an
auto-parts supplier when their earnings have gotten crushed and the P/E has
gotten high and people are afraid that the world's coming to an end." His
suggestion: Buy the stocks and trade them or hang on to them for a long time
-- perhaps five years.
One selection method is to find the companies that have the best new
technology, on the theory that even if vehicle sales tank, a rising percentage of
the new cars and trucks built will incorporate that technology. The parts or
systems that have the highest technology generally go first into luxury vehicles.
Thus, they generate the highest margins and are the least likely components to
be auctioned via the 'Net.
To produce innovative technology, however, considerable research and
development outlays are a necessity. The accompanying table, provided by
the folks at Dresdner Kleinwort Benson, lists many of the biggest suppliers
and the amount they spend on R&D, relative to sales. It also gives the
companies' debt levels, which could be quite telling if a recession struck.
Tadross' pick of the group is Gentex, which has advanced technology for
self-dimming mirrors used in vehicles and elsewhere. The stock recently was
trading at $34, and Tadross sees the company earning $1 a share this year
and $1.20 in 2001. Another of his favorites: Johnson Controls, which
integrates electronics in a car's interior and also gets 25% of its business from
building controls. The analyst sees the company earning $5.15 and $5.75 in
calendar 2000 and 2001, respectively. It recently was changing hands at
around $59.
"I'm [generally] a bear on the auto-parts group, but Delphi is the one story for
me that has legs," says Darren Kimball, managing director at Lehman
Brothers. Delphi, formerly part of GM, has focused on the multimedia
opportunities in cars. In other words, it's making appliances that offer Web
capabilities, e-mail, location guides, television and voice synthesizers.
"No cars have them today and 25 million will have some form of telematics
[integrated communications, Internet and other electronic services] or mobile
multimedia in five years," says Kimball. He sees Delphi, which recently was
changing hands at $18, earning $2 a share this year and $2.15 next year.
So, for at least a few of the companies, the parts could add up to a whole lot
more than the market currently is giving them credit for. |
