Can't build a car without parts

Production cuts and tight credit are hurting companies that will supply the parts when auto sales come back.

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By Peter Valdes-Dapena, CNNMoney.com senior writer

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Auto-parts suppliers may be so weakened by the current economy that it could hold back the industry's eventual recovery.

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NEW YORK (CNNMoney.com) -- Hundreds of auto-parts suppliers, companies that make all the things that go into new cars, could fail this year leading to industry disruptions and big job losses.

What's more, when Americans are ready to start buying cars again - projected to happen in about a year - the industry may find itself unable to build them.

"Things are bad and they are going to get worse very rapidly," said Neil De Koker, president of industry group the Original Equipment Suppliers Association.

At least 10% of the auto-parts suppliers in America face bankruptcy this year unless actions are taken to free up credit for the industry, De Koker said. That would mean about 7,300 jobs lost from parts suppliers, but the full effect could be almost five times as large. When a supplier shuts down, other related companies tend to go down too.

While government loans have helped ensure the near-term survival of some of the suppliers' biggest customers, production cutbacks combined with tight credit markets have created urgent cash flow problems for many parts companies, according to De Koker.

Auto factory shutdowns later this year won't be caused by lack of demand for the product, but by the inability to produce it due to lack of parts, said Kimberly Rodriguez, an analyst with consultants Grant Thornton.

"The OEMs can pay their receivables, but that's only a small piece of the pie," said Rodriguez.

OEMs, or original equipment manufacturers, is an industry term for automakers as opposed to parts suppliers. If a major automaker were to go bankrupt, De Koker said, the number of auto-parts suppliers facing failure would rise to as much 25%.

Squeeze at the top

Automakers, themselves struggling to survive a crushing drop in demand, can't do much to help, said a source at one automaker, even though they see this as a problem that will, ultimately, become their problem.

"This is a tremendous concern," said an auto company executive, who asked not be identified. "There is tremendous chaos in the industry."

It typically takes 45 days from the time a supplier sends parts to a carmakers' factory until the bill for those parts gets paid. While they wait for the checks to arrive, parts suppliers typically take out loans, using those "accounts receivable" invoices as collateral.

With auto sales down, automakers are slowing down production and idling factories. That means, of course, fewer orders for parts. That means fewer invoices against which to borrow to pay current costs.

To make matters worse, many banks are simply refusing to lend at all against accounts receivable from domestic automakers, said De Koker.

"We can't borrow money on a normal basis," De Koker said, "because the banks just quit lending money, especially in the automobile industry."

Asking for government bailouts, similar to those received by General Motors (GM, Fortune 500) and Chrysler, isn't feasible, De Koker said. There are only a few major automakers, but thousands of parts suppliers.

What the government could do, De Koker said, is help to free up credit for the industry.

"The banks need assurance that it is safe to lend to the automobile industry," he said.

De Koker suggests that government provide guarantees on loans based on accounts receivable from domestic automakers. While that wouldn't make up for production cuts, it would at least restore the normal flow of money based on the current level of orders.

The automakers can offer some help to their suppliers when the need is critical. For instance, automakers are sometimes asked to make quick payments for the parts they receive, which lessens the need for suppliers to rely on loans.

So far in January, 2009, automakers have received more requests like this than they received in all of 2008, said Rodriguez.

But the automakers are struggling, too. "If suppliers started asking for that, the cash we have would just evaporate," said the auto executive.

Trouble from the bottom

The biggest risk, Rodriguez said, isn't with the big parts suppliers that ship directly to the automakers. Those companies, the ones that provide finished parts like seats, instrument clusters and headlights to automakers, tend to be bigger, more mature companies that are better prepared to handle market challenges in a way that, at least, minimizes disruption, she said.

The real danger lies in failures of companies further down in the chain, she said. These are the companies that supply things like wiring, springs or raw materials to companies that make the larger components of a car.

The further down the supply chain failures happen, the broader the impact spreads, Rodriguez said. While one company that makes seats, for instance, might supply several automakers, a company that makes wire frames or foam inserts might supply more than one seat company and those seat companies would, in turn, supply a much larger number of automakers.

Given the state of the industry - auto sales last month were running 36% behind the pace set a year earlier - there is simply no way to support the number of parts suppliers currently in business, Rodriguez said. A culling of some sort has to take place.

"My fear is that consolidation will not be as orderly as it could be," she said, "and that will cause substantial production shutdowns that would not help the industry at all."

Factory shutdowns caused by supply chain disruptions will likely begin later this year, she predicted. Auto sales are expected to begin picking up a bit in early 2010, according to industry analysts at CSM Automotive.

Rodriguez recommends a solution to the credit crisis problem similar to that suggested by De Koker: loan guarantees. But Rodriguez would like to see a requirement that multiple lenders participate in each loan as a way of ensuring creditworthiness and spreading risk.

One positive side of the current crisis in the market, said Shelly Lombar, a bond analyst with Gimme Credit, is that companies are seeking help sooner. That's because, with credit markets frozen, companies have no cushion to save them.

"You can't wait until you're down to your last $5 to go into bankruptcy," she said.

But the credit problem, alone, should be relatively easy to solve. Bringing back the customers will be harder.

"The 'more production' part has to come from consumer confidence and more people buying cars," she said. To top of page

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