Supply chain and earthquake costs hurt carmakers' profits

 

Most earnings released thus far were in line with expectations, with particularly strong results from Hyundai, whose second quarter profits rose 37% compared to last year, Kia, whose rose 67%, and the Volkswagen Group, whose profits nearly trebled. Premium carmakers BMW, Porsche, Audi and Mercedes each recorded very strong profits, with BMW performing best, seeing profits rise 66%.

 

These carmakers had in common record-breaking vehicles sales as well as minimal supply chain disruption following the Japanese earthquake. However, most warned of rising fuel and material costs in the second half that could hurt profits. Analysts have also warned that Hyundai and Kia could face difficulty from the appreciation of the South Korea won against the dollar and the euro, both of which have lost value following concern over debt levels and economic uncertainty. BMW and Daimler also warned of a slowdown in the second half, even among emerging markets like China. Meanwhile, VW said that disruptions resulting from the Japan quake would be limited but could not be ruled out.

 

Ford saw its second quarter profits fall by about 7%, although it was still $2.4 billion including a very strong performance in North America. But Ford too warned of threats from rising material costs, which has already hurt its performance in Europe.

 

Japanese carmakers generally reported falls in profits as a result of production stoppages because of parts shortages, as well as the strength of the yen. But performance was generally above expectations, with Nissan reporting a less-than-anticipated 10% drop in operating profit, while Honda saw profits drop 90%, despite expectations that it would registered a loss. Mitsubishi also remained profitable (dropping 42%) on strong European and American sales, while Mazda, which exports 80% of its production from Japan, reported a loss of 23.1 billion yen ($285.3m) compared to an operating profit of 6.4 billion yen a year earlier.

 

Toyota made an operating loss of 108 billion yen from a 211.7 billion yen profit a year earlier, although the result was better than expected. Toyota’s supply constraints have eased faster than expected, although inventory remained hampered even in July, which has seen both Toyota and Honda see sales declines of more than 20% in the US, for example. Also, with the yen currently trading below 80 to the dollar and around 110 to euro, Toyota executives have warned that the company may not be able to keep as much production in Japan as it does currently.

 

Most Japanese carmakers are expected to return to full production by the end of the summer and autumn, although lingering supply disruptions remain possible.  

 

Renault and PSA both reported drops in earnings in part because of slowdowns in France and Western Europe, exacerbated by supply constraints. Renault’s operating profit dropped 4% in the first half of 2011 compared to 2010, even as revenue rose 7%. PSA’s automotive division’s profits fell by 23% (although its logistics subsidiary, Gefco, saw profits rise 17%). As with Ford and VW, both carmakers pointed to rises in material costs that were higher than anticipated. Renault said that raw material costs rose by €313m ($445m) in the first half, while PSA said costs rose by €366m.

 

The situations outlined by French-based manufacturers highlighted the complex situations that carmakers are facing in the supply chain and the significant risks that disruption to both the inbound and outbound supply chain have posed to sales and operating profit even for non-Japanese companies (although Renault's ownership ties to Nissan may have made it more exposed than most).

 

Renault estimated that the Japanese earthquake had knocked nearly €150m off its operating profit in the first half, with another €50m anticipated for the second half. According to Renault’s new chief operating officer, Carlos Tavares (who was most recently head of Nissan Americas), about 80% of those costs were the result of poorer pricing and lost sales because of the impact to Renault’s volume mix and delayed deliveries.

 

PSA pointed to the same issue in its earning report, with increased delivery times leading to higher incentives and poorer pricing. PSA estimated the negative impact from Japan to the company’s profits to be around €147m in the first half.

 

Renault has faced an even more difficult supply situation than PSA or other European and American carmakers because of an earlier shortage of diesel engines. “We underestimated our diesel mix, particularly in France, which is why we were in short supply even before the Tsunami,” Tavares said, speaking on a conference call. “That is also why two weeks ago we announced an €150m investment to increase powertrain capacity by 25%, which will help us overcome this historic bottleneck.”

 

Tavares said that about 10% of the €150m in Japan-related costs in the first half were for emergency freight logistics that resulted from Renault having to find upstream replacement parts. Another 10% of the costs were research and development related, said Tavares. “These R&D costs rose because our staff was busy controlling availability of parts rather than [focusing] on strict stock control,” he said.

Tavares added that another factor in increased logistics costs partly-related to the earthquake came from from carrying higher levels of vehicle inventory, up by about 80,000 vehicles compared to last year, to 59 days supply. While it may appear counterintuitive that the company would have higher levels of inventory following supply chain disruptions, Renault’s CFO Dominique Thormann said it was partly down to problems with Renault’s product mix (such as having too many gasoline-powered cars compared to diesel). He also pointed to product build up before the summer break and to partially finished vehicles. “Because of supply issues, we partly completed as many vehicles as possible while waiting for certain components that we could add later as they became available, including Bluetooth and radios,” he said.

 

Tavares added that increased exports of vehicles overseas was responsible for about 26,000 units of the inventory increase, as these cars need longer waiting times prior to shipping.  

 

PSA also pointed to an increase in inventory in the first quarter following the Japan quake. The company said it was carrying around 76 days of inventory going into the summer shutdown period.

 

Finally, Tavares said that South Korea-based Renault Samsung, owned 80% by Renault, had struggled in the first half more than other Korean carmakers because the company relies on a substantial amount of parts from Japan. Tavares was honest was responding to questions about when further localisation would occur in Korea. “I don’t know, but it is something we must do,” he said.

 

In response to rising fuel, material and production costs, carmakers appear to be more focused on supply risks and total supply chain cost reduction plans, a trend that Automotive Logistics has noted already with General Motors ‘total enterprise cost’ programme, Daimler’s ‘total logistics cost’ approach and Renault’s adoption of Nissan’s monozukuri cost reduction plan. According to Tavares, “With Monozukuri we might be willing to increase some lines of the value chain in order that the total cost is lower.”

 

Renault has set a three year target of saving 12% of delivered cost, or €2.4 billion. In the most recent earnings, Renault gave some insight into its progress. In the first half of the year, the company economised nearly €280m, including €5m saved in logistics cost. “Our logistics savings would have been substantially higher had it not been for premium freight costs related to Japan,” said Thormann.

 

Tavares admitted that the company is not on track to meet its efficiency target for 2011, but he said he is confident it will achieve its three-year goal.

 

PSA, meanwhile, has a goal to improve manufacturing productivity by 20% over the next three years. Guy Lederer, executive manager for international logistics, told Automotive Logistics that PSA has switched to a total cost analysis and that the company is working harder to create medium term forecasts integrating more logistics cost, air freight risk, obsolescence, quality and tax evolutions. “We now have a midterm, 3-5 year vision for what the flows should be, where our supplier will be located, the cost of diesel and what solutions would be the most cost effective and environmentally friendly,” he said at a recent interview at PSA's offics in Poissy, outside Paris.

 

Lederer added that since PSA has adapted this focus, it has relied less on sourcing from the lowest cost locations. “Since we changed our approach, lowest purchasing cost is no longer a priority,” he said. “Decisions cannot be made in a micro-economic way alone. We might be able to save €1 on a specific alloy wheel or a colour if we were to source it in a low cost country for other locations, but from the total cost point of view it would be a real mess.”

 

Similarly, Rebecca Vest, the head of purchasing in North America for Nissan, told a conference in Michigan this week that she wants 100% of its parts to be "close to the plant," according to Automotive News. Vest said that because of the strength of the yen and other disruptions, her biggest headaches are coming from outside the region.

 

"We're going to look at the total delivered cost to determine your competitiveness," she said. "But generally speaking, a supplier in New York is going to have a tougher time being competitive supplying our plants in Mexico than a supplier who is on the ground in Mexico."

 

With supply chain costs expected to rise, such  focus on localisation and total cost appear likely to increase. Renault predicts that raw material prices could total €600m by the year end, while Philippe Varin, CEO of Peugeot, said in a conference call that rising costs will also hurt profits in 2012. Even before the earthquake, Toyota has been striving to reduce costs by around 30% to keep its production competitive, with plans to cut costs in Japan alone by 20% with the target of producing at least 3m vehicles per year in the country. At the same time, the company has said it would increase localisation at its global manufacturing plants.