BRICS Auto Parts Focus

BRIC and Auto Parts

Globally, the auto-parts industry is running on a major flat, experiencing a blowout of demand due to production cuts at struggling vehicle manufacturers. They’re expected to slash auto-part employment in this country by more than a third this year, according to the Conference Board of Canada. But unlike Michigan’s Lear Corp., which just joined its home-state competitor Visteon Corp. in seeking Chapter 11 protection from creditors, Frank Stronach’s Magna International Inc. isn’t cruising in crisis mode. Instead, the Aurora, Ont.–based company, the third-largest and most diversified automotive supplier on the planet, is looking to feast on industry road kill.

Launched in a Toronto garage by Stronach about five decades ago, Magna hasn’t been immune to sector woes. The company, which has been forced to shutter plants and eliminate thousands of jobs, posted a net loss of US$200 million in the first quarter, when light-vehicle production in North America and Europe plummeted 50% and 40%, respectively. Sales dropped to US$3.6 billion, a 46% decline from Q1 2008 — when Magna reported a gain of US $207 million.

But Stronach’s operation, which employs 70,000 people in 25 countries, has a non-union culture, so it doesn’t face the labour cost issues that helped park General Motors and Chrysler (which jointly accounted for 30% of Magna’s Q1 sales) in bankruptcy court this year. Like Canada’s other two major sector plays — Martinrea International Inc. (TSX: MRE) and Linamar Corp. (TSX: LNR) — Magna is free to rev up M&A activity because it is fuelled by a healthy balance sheet.

Unlike the competition, however, Magna is chaired by Stronach, who controls the company via controversial dual shares that turn off institutional investors. And he is raising eyebrows by voicing a desire to shift his auto empire’s gears by ramping up assembly operations. In other words, Stronach apparently thinks it is a good idea for Magna — which currently builds outsourced vehicles at a single assembly plant in Austria — to compete head-to-head with customers in emerging and developed markets alike.

In May, Magna and Moscow-based Sberbank made a joint non-binding bid for control of Germany’s Adam Opel GmbH, the main arm of GM’s European operations. If completed, the Kremlin-controlled lender is expected to transfer its stake to Oleg Deripaska, an oligarch with auto interests, not to mention friends in Moscow, who would then open the door to a rapid Magna expansion into Russia.

The $700-plus-million Opel play isn’t the first time Magna has appeared willing to roll the dice on a major expansion of assembly operations. At the company’s annual general meeting this year, Stronach admitted the company “dodged a bullet” by losing the bidding war for Chrysler two years ago. The focus on Russia also isn’t new. In 2007, Stronach cut a deal to share control of Magna with Deripaska, who invested US$1.5 billion in the Canadian firm at the time. But the Russian’s direct involvement with the company ended late last year, when a liquidity crisis forced a sale of his equity stake.

According to Magna spokeswoman Tracy Fuerst, the “working relationship” with Deripaska’s GAZ auto-making group has remained strong. Still, Magna’s renewed focus on Russia and eagerness to compete with customers is generating mixed reviews. “Not many investors we speak with seem terribly anxious about a potential Magna-Opel tie-up,” Itay Michaeli, an analyst with Citigroup Global Markets, declared in a research note. He argues the Opel deal represents a “low-risk” investment that would, if completed, generate future goodwill with GM.

But other industry watchers see the Opel bid as a high-risk strategy, which is why 12-month analyst stock price targets are all over the map, ranging from $32.74 to $59.03. (At press time the stock was trading around $48.)

Clearly, not all of Magna’s customers are happy over the company’s play to become a full-blown automaker.

While bidding for Chrysler, Stronach could at least claim he was out to aid a troubled client. Opel, however, attracted other suitors, including Beijing Automotive Industry Holding Corp. And even if Magna doesn’t close the deal, it still threw a wrench in Chrysler’s survival plan — since the Canadian bid put Fiat out of the running, and the Italian car company had hoped to buy Opel as part of the strategy it developed when agreeing to take over the Detroit automaker. Shawn Morgan, a Chrysler spokeswoman, declined to comment on the company’s relationship with Magna. But Volkswagen has said it is watching developments with some apprehension.

Carlos Gomes, an auto-sector analyst with Scotia Capital, Magna’s focus on Russia could also prove to be riskier than deal supporters want to admit. He acknowledges that Russia has a low vehicle-penetration rate (about 180 vehicles per 1,000 people), compared with roughly 560 vehicles in western Europe, so the potential is enormous if its energy-dependent economy recovers. Still, he thinks “Russia likely has the weakest outlook among the BRIC nations because of declining population.”

Bill Witherell, an adviser to the Organisation for Economic Co-operation and Development and chief economist with New Jersey–based Cumberland Advisors, is also bearish on the Russian economy, which is projected to decline 8.5% this year. He thinks emerging-market strategists should focus on BIC economies, noting Russia — where IKEA recently suspended operations due to the “unpredictable character” of administrative procedures — sits between Syria and Kenya on the 2008 Corruption Perceptions Index.

Michael Willemse, an Toronto-based analyst with CIBC World Markets, says Magna shareholders are obviously uncomfortable with the Opel bid. But he thinks a related sell-off that weakened the share price was probably overdone. Simply put, he doesn’t believe Magna’s co-CEOs — Don Walker and Siegfried Wolf — would be willing “to inject a material amount above the original investment,” which would be inconsistent with “Magna’s desire to maintain a strong balance sheet.” If Magna’s management was blindly focused on becoming a global automaker, Willemse argues the company would have been more aggressive pursuing other deals over the past two years. But he admits there is a risk that Stronach has taken the wheel from his CEOs to drive Magna into auto-making in a major way.

BRIC and Auto Parts