CHICAGO -- U.S. auto suppliers burdened with heavy debt loads risk credit downgrades and breached bank covenants if Detroit's vehicle production levels continue to shrink, analysts said.
Slowing auto sales and rising inventories have prompted automakers General Motors and Ford Motor Co. to announce production cuts for the second quarter.
If the lower build rates continue, suppliers , which make everything from chassis and interior assemblies to steering, braking and electrical systems, will feel the squeeze.
"If we stay at that level, there are going to be problems," said David Leiker, equities analyst at Robert W. Baird & Co.
Among companies with a negative outlook from Standard & Poor's Ratings Services are No. 1 U.S. auto supplier Delphi Corp. and No. 2 Visteon Corp., whose corporate debts are investment-grade, and Goodyear Tire & Rubber Co. and Tower Automotive Inc., whose debts are high-yield.
Auto suppliers have made a priority of paying down debt in the past two years after borrowing heavily to fund acquisitions during the industry consolidation of the 1990s. But analysts said debt levels at some companies remain uncomfortably high.
"They have done a good deal of paying down debt. Is it where it needs to be? Probably not," said George Meyers, credit analyst for Moody's Investors Service.
CAR SALES SLOW
New car sales have slowed this year as the stagnating economy and war with Iraq hurt consumer confidence. Many analysts believe car demand may have reached a saturation point after years of strong sales fueled by aggressive consumer incentives.
Weaker sales and production cutbacks could intensify the pricing pressure suppliers already face as automakers require deeper price cuts to boost their own profits, said Martin King, credit analyst with Standard & Poor's Ratings Services.
Suppliers are also grappling with higher costs for employee benefits, insurance and raw materials.
"If market conditions do not improve, we expect a number of companies to face earnings pressures, tighter liquidity and difficulty meeting financial covenants, which could lead to rating changes or outlook revisions," King said.
Analysts cautioned the impact of a weak car market on any individual parts maker depends on which vehicles that company supplies and whether it has a technology edge, flexible work force or is highly leveraged.
"Different suppliers have different cost structures and different exposures, so they don't all get affected in the same way," said Scott Lee, credit analyst for Fitch Ratings.
A lower credit rating raises a company's borrowing costs by increasing interest rates demanded by investors who want to be compensated for greater risk.
A few suppliers even face a greater risk of default if weak auto sales persist, said King of S&P. Among them, Tenneco Automotive Inc. stands out for its high debt to capital ratio of 107 percent.
ADEQUATE CASH FLOW
Tenneco Automotive, whose debt was inherited after one-time conglomerate Tenneco spun off its packaging business in 1998, said it has since paid down $300 million, is in compliance with bank covenants, and has adequate cash flow.
"We are a long way from being in a default situation," CFO Mark McCollum said.
S&P last month lowered Visteon's outlook to negative from stable and its short-term credit rating to "A-3" on concerns about "subpar profitability and cash flow generation" due to industry pressures and lower production at main customer Ford.
Spokesman Greg Gardner said Visteon at year end had $1.3 billion in cash on hand after paying down $300 million in debt and generating more than $500 million in cash flow in 2002.
"We have one of the stronger balance sheets in our sector, and our liquidity position remains strong," he said.
ArvinMeritor Inc., recently placed on "credit watch negative" by S&P, faces a potential downgrade out of investment grade due to difficult market conditions, the agency said.
Beth Gurnack, vice president of investor relations for ArvinMeritor, said U.S. automakers' lower production schedules are closer in line with its own more conservative estimates.
"With the builds coming down, it's not a Draconian reduction from where we thought it would be," Gurnack said.
S&P said Collins & Aikman Corp. and Dura Automotive Systems Inc. have stable outlooks now that could come under pressure this year, while Lear Corp.'s credit rating could rise to investment grade if the company continues to reduce debt and maintains solid earnings and cash flow.
Suppliers with stable outlooks that analysts expect to perform well include American Axle & Manufacturing Holdings Inc., BorgWarner Inc., Johnson Controls Inc. and Magna International Inc.