Below we discuss a few more observations from the show as well as some other thematic developments that are likely to have bearing on the Aftermarket.
Is more manufacturer consolidation likely? While the entrance of emerging foreign manufacturers first made news in 2006, we believe this trend was only amplified further at AAPEX last year, as the lower lobby of the Sands Expo Center was filled primarily with foreign manufacturers (mostly Asian) looking to establish a U.S. presence. Exhibitors showcased all sorts of product lines including brakes, clutches, flywheels, ignition sets, starters, and heating and cooling components. This past week, while it seemed as though there were at least as many different foreign entrants in attendance, it did not seem as though there were nearly as many interested buyers pacing the floor—not only relative to last year, but also in comparison to the upper AAPEX level (which is dominated by the more traditional mainstays of the aftermarket — Cardone, BOSCH, Affinia, Federal-Mogul, Standard Motor Products, and Dorman Products). So, what could be the primary drivers of the decrease in buyer interest in and attention to these foreign parts providers? We think there are several: more downstream companies paying attention to the fully landed costs of direct sourcing product lines (significant lead time, oftentimes limited recourse with returns and quality control issues); U.S.-based aftermarket suppliers have become more competitive in price; and many buyers know that their larger vendors are not in the best of financial health (i.e. if I give more of my business to smaller foreign entrants, who can I call on to supply my core parts lines if my mainstays are forced out?). We are not saying that demand for foreign sourcing has been abandoned, but rather that the trend has certainly slowed from what seemed to be such a dominant theme of 2005 – 2007. While many warehouse distributors and retailers are aware of the potential for material "savings" from direct sourcing, we believe that other aspects of the procurement shift, which have become more apparent with time, have made many realize that the true landed cost of sourcing abroad is oftentimes as high or higher than that obtainable from more mainstay domestic part manufacturers. We maintain our view that it will take at least the next few years to truly evaluate the value proposition of these foreign-based entrants, but they nonetheless are changing the traditional landscape of parts procurement. In our opinion, more consolidation across the manufacturer base is likely (and even necessary) as it seems to us as if there is simply an excessive number of suppliers and an abundance of parts inventory that is sitting idle. This excess capacity of supply has placed significant downward pressure on manufacturer margins. Coupled with the lock-up in credit markets that has increased pricing and reduced availability in factoring programs, we believe that the next year or two could mark a fairly pronounced period of supplier base contraction and consolidation.
Is there a potential 'silver lining' from the OE turmoil? It comes as no surprise that the OE network is facing considerable pressure, with rapidly declining new vehicle sales volumes (10.9 million SAAR in October, down from 16.0 million a year ago) brought on by a combination of the slowing economy and consumer spending, in addition to more stringent vehicle finance requirements. But it will be interesting to watch how these trends in the OE and dealer channel impact the aftermarket. In our opinion, these stresses should result in enhanced opportunities for most aftermarket participants over the next few years. For one, we think that aftermarket retailers and distributors could see enhanced gross margin opportunities from improved pricing on parts procurement as there is already excess manufacturing supply and many tier one OE parts suppliers will probably look to expand their aftermarket exposure (as a relative safe haven). Additionally, we think more dealership closings are likely in the months to come, and although those that remain will probably become more aggressive in targeting additional part and service sales, the potential for the independent aftermarket to recruit and retain highly qualified, OE trained technicians should not be underestimated.
What can past recessions teach us about Aftermarket performance this time around? Since November 2007, miles driven have declined year over year for 10 consecutive months (through August, most recent data point). So, in conjunction with dramatically lower gasoline prices (national average now $2.22 vs. the July peak of $4.11), this industry now faces easier comparisons in miles driven, which ultimately is the largest determinant of vehicular parts failure. While the operating environment is likely to remain challenging for the next few quarters, we think it is important to remember that the auto aftermarket has faced recessionary headwinds since spring 2006 (when the national average for gasoline approached $3.00/gal), and do not believe that this industry will see another material leg down in terms of sales volumes. Many investors have expressed concern over the potential impact of higher unemployment levels on miles driven, in spite of the significant retreat in fuel prices, as the larger macro economy continues to exhibit signs of stalling. Looking back at the two more severe recessions in recent times ('73-'75, and '79-'82), miles driven saw a sustained period of yr/yr declines on a per capita basis well in advance of the unemployment rate reaching new recessionary-level highs (see Figure 1). In addition, while significant unemployment rate increases lagged changes in miles driven, proxy industry sales tended to track much closer—implying that the weakness in SSS trends for aftermarket participants over the past two and a half years may not necessarily take another material turn for the worse. So, while we are not calling for a bottom, we do think this industry is closer to seeing normalization and possibly stabilization in sales volumes moving into the latter spring months of 2009. If there was a month where we would have some concern, it would be December, where disposable income will likely be limited to holiday spending.
About BB&T Capital Markets:
BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the Automotive Aftermarket industry. BB&T Capital Markets is a division of Scott & Stringfellow, Inc., NYSE/SIPC. Scott & Stringfellow is a registered broker/dealer subsidiary of BB&T Corporation, one of the nation's largest financial holding companies with $137 billion in assets.
Disclosures:
BB&T Capital Markets makes a market in the securities of Dorman Products, Inc.; Monro Muffler Brake, Inc.; Motorcar Parts of America, Inc. and O'Reilly Automotive Inc.
BB&T Capital Markets has managed or co-managed a public offering of securities for AutoZone, Inc. in the last 12 months.
BB&T Capital Markets has received compensation for investment banking services from AutoZone, Inc. in the last 12 months.
BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Advance Auto Parts, Inc.; AutoZone, Inc.; Dorman Products, Inc.; Genuine Parts Company; Midas, Inc.; Monro Muffler Brake, Inc.; Motorcar Parts of America, Inc.; O'Reilly Automotive Inc.; Standard Motor Products, Inc. and The Pep Boys—Manny, Moe & Jack in the next three months.
Monroe Muffler Brake, Inc. is, or during the past 12 months was, a client of BB&T Capital Markets, which provided non investment banking, securities-related services to, and received compensation from, the aforementioned company for such services. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report knows the foregoing facts.
An affiliate of BB&T Capital Markets received compensation from Advance Auto Parts, Inc.; AutoZone, Inc.; Genuine Parts Company; Midas, Inc.; Monro Muffler Brake, Inc. and O'Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know or have reason to know the foregoing facts.
