Central Europe driven to despair

By bne IntelliNews March 27, 2009

Jan Cienski, Nicholas Watson and Kester Eddy -

Leszek Woliszewski is a worried man as he walks through his car parts factory in the eastern Polish town of Krosno looking at the idled machinery that was humming with life just a few months ago. "Sales have almost completely stopped," he says. "It's very painful and difficult to manage."

Woliszewski built up his business FA Krosno, which makes gas springs, shock absorber components and steel components, in 2006 when Central Europe was rapidly becoming the continent's Detroit - a hub of low-cost car manufacturing that was attracting factories from around the world.

The boom ended last year, when first the US market went into a tailspin and European sales followed suit towards the end of the year. Carmakers immediately began to throttle back on production and to run down their inventories, hammering companies like FA Krosno. "We began to feel it at the beginning of last year, and orders fell sharply in November when the crisis reached Europe," he says sitting in his small office near the shop floor where workers have been put on part time and seen their pay reduced, all in an attempt to save jobs. "The first reaction of the carmakers is to cut orders and to rely on inventory."

One of the reasons for Woliszewski's troubles can be found at the other end of the country, at the Opel factory near the city of Gliwice. There, Antonio Francavilla, General Motor's country manager for Poland, says the plant was doing well last year "until the floor fell out from under the market."

Opel, GM's European unit, has been pummelled by the downturn and says it needs financial support to survive. Opel said sales fell by 22% in February, the steepest downturn for a large European manufacturer. In January, the Gliwice factory built just 5,200 cars, about 12,000 less than in the same period a year earlier.

The Gliwice factory, one of 10 Opel plants in Europe, is the company's lowest-cost producer on the continent, thanks to which it's taking over production of the new Astra model from a factory in Antwerp. Francavilla, an enthusiastic Italian-Canadian, proudly shows off the machinery fresh from Belgium being installed in a production hall. But Opel's troubles point to the fact that the futures of many such plants in Central Europe and elsewhere on the continent, including the one in Gliwice, are cloudy.

Changing down a gear

So far, Francavilla has cut back from three shifts to two, and let contract workers go. The factory has also taken several production holidays as it tries to shore up its position. It has been hit hard because it relies on Astra as well as Zefira minivans, models that aren't in favour with cash-strapped buyers in Western Europe.

Just down the highway from Gliwice, Fiat's factory in Tychy is still going strong, and the Italian carmaker plans to invest about €400m in a new gasoline engine factory. According to Samar, an auto consultancy, the factory in Tychy is now Fiat's largest and the only car factory in Poland to show an increase in production in January. In total, Poland's car factories produced 58,800 cars and light trucks in January, 30,000 less than in January 2007.

Fiat says it's still holding on because consumers still in the market for a new car are shifting their tastes towards smaller and cheaper vehicles. "In the current difficult and changeable circumstances it is hard to be certain about future plans, but if sales of economical, ecological and inexpensive cars continue as they until now, we expect to produce about the same number of cars as last year, about half a million," says Boguslaw Cieslar, a Fiat Poland spokesman.

However, not all low-cost carmakers are as sanguine. In Slovakia, which has three big car plants and is one of the world's highest per capita car producers, South Korea's Kia is very worried. "The situation is changing really rapidly," says Dusan Dvorak, a spokesman for Kia, which has a factory in the northern Slovak city of Zilina. "It's almost impossible to predict sales at the moment." Last year, in its second full year of operation, the Kia factory made 201,000 Cee'd models and Sportage small SUVs; this year, the factory, which has cut hours and took a production break in January, could make 170,000 or less.

Volkswagen's factory near the Slovak capital of Bratislava has been even harder hit, as it focuses more on luxury models like the Audi Q7, the Volkswagen Touareg SUV, as well as bodies for the Porsche Cayenne, in addition to more downmarket Skoda Octavias. On March 18, Volkswagen Slovakia's CEO Andreas Tostmann said the firm's production fell to 188,000 cars last year, from 249,000 vehicles in 2007. He declined to give an output figure for this year, but warned that demand is falling markedly. "We are preparing for a tough year," he said.

Overall, Slovakia's three carmakers - including France's PSA Peugeot - last year produced 587,000 cars, but this year the car manufacturers are warning that production could fall by a quarter. Given that Volkswagen Slovakia alone is responsible for about 15% of Slovakia's GDP, this is having a devastating affect on the country's economic situation. Slovak exports took a sharp hit in January, plummeting by almost 30% on year in euro terms. Slovakia's trade balance swerved into a deficit of €280m in January, shifting from a year-earlier surplus of €42m.

In Hungary it's the same story. The auto sector has been a crucial part of the new economy created since the country began its transition in 1990; it produces 17% of industrial production, generates almost 25% of manufactured exports and provides, directly and otherwise, 100,000 jobs, according to the Ministry of Economy. That ministry's latest data, however, reveals the sector has seen 7,520 job losses in the last six months as the number of new vehicles sold in Hungary during the first two months of 2009 plummeted 49% on year.

Last September, Magyar Suzuki Corporation, the Hungarian subsidiary of the Japanese automaker, showed off a five-door, 1.2-litre, turquoise-lagoon-painted Splash - the 1.5mth car to roll off the production line in 17 years of operations. A month earlier, celebrations were for a record 149,500 vehicles from three models - the Swift, SX4 and Splash - produced in the first half of 2008. This was 33% up on 2007 production, and talk was of hitting 300,000 in the year, 90% for export.

Alas, by December, Magyar Suzuki was grappling with falling demand; it restricted workers' buses to a 30-kilometre radius centring on its Esztergom factory, and announced cuts of 1,200 jobs in its 5,500-strong workforce from the New Year as the company moved back to a simple two-shift, five-day week system; previously, it had operated three-shift, 10-hour days. As a result of the slowdown, Magyar Suzuki missed that 300,000 target, although the production of "more than 280,000 units," 20% up on 2007, still broke previous records, spokeswoman Viktoria Ruszka says, trying to put an optimistic spin on things.

Ruszka says Magyar Suzuki will "continuously adjust" production this year to meet demand, and while she declines to specify an exact figure, expectations this year are for some 200,000 vehicles. "We are averaging 850 or more daily, it seems we can keep [to] this. Demand is slowly getting better from Germany and some other markets, although I don't want to put a figure on this. For us 2009 is about cost saving and maintaining our markets, including domestic sales."

But amongst the ruins there are signs of life. On March 3, Dieter Zetsche, chairman of Daimler, confirmed that plans to build a Mercedes-plant in Kecskemet, central Hungary would remain unchanged. The new plant, an €800m investment employing 2,500, is three months late due to planning permission hold-ups, but it will start production in 2011, Zetsche confirmed. In February, Japanese automaker Honda Motor's European affiliate announced it had purchased 56,000 square meters of land in Pniewy, western Poland for a new logistics centre and parts depot. The automaker is expected to invest €11m on the plant, which should become operational in 2010.

These new investments lend support to Magyar Suzuki's Ruszka contention that we might be nearing the bottom of the volume cycle in Europe. That's not to say the market won't continue to decline in 2009 - industry predictions put European car production at down 25% this year - but that it will fall at a decreasing rate throughout year before eventually recovering to a lower level than when the crisis hit. "Business Monitor International believes a decline in Polish vehicle sales is inevitable in 2009 as consumer confidence is rattled by a reduction in credit availability and heightened uncertainty," the economic consultancy says. "However, Honda's site may just be ready to cater to markets as we forecast a strong recovery in 2011, with growth of around 24% in line with a rebound in economic growth and the release of pent-up demand caused by consumer wariness."

Misty windscreen

The actual length of the downturn will depend in no small part on the actions of the EU and its member states. For better or for worse, governments will play a bigger role in the Europe's car industry for the foreseeable future.

Several EU governments have already announced huge bailout packages to help their car industries survive the current global recession. In February, France unveiled a €6bn state loan for Renault and PSA Peugeot-Citroen in return for an unwritten pledge not to close facilities in France during the duration of the loans. Five other EU countries - Germany, Italy, Spain, Sweden and the UK - have also announced their own plans to offer financial assistance to carmakers.

The European Commission has decided these aid packages comply with the bloc's internal market rules. However, what the executive didn't like was another example of French President Nicolas Sarkozy's seeming nationalistic Tourette's syndrome with an outburst about the aid being conditional on France's carmakers not moving production to the lower-cost east. Sarkozy has since backtracked on his comments and at an emergency summit on March 1 EU leaders stressed the need to avoid undermining the internal market through any protectionist measures to shield national industries and jobs. However, rising fears of protectionism have taken hold in Central Europe, where such measures would bite particularly deep.

In addition to loans, European governments have also announced packages to stimulate consumer demand in the car market. These include incentive schemes for consumers to replace their old gas-guzzling cars with new, greener models (see sidebar, "Romania's Dacia Logan becomes cult car for crisis-hit Germany").

The aid package being most keenly watched is that for Opel, which apparently has sufficient financing to see it through into April, but after that will require at least €3.3bn of aid. Without it, Opel says, it will probably have to close three of its 10 European plants. Germany said it's open to the possibility of helping Opel, but insists it needs to be sure no state support would find its way to GM, which is seeking more bailout help from the US government to survive. GM Europe has submitted a rescue plan for Opel that would see its German unit partly spun off from its parent.

The possible insolvency of Opel would be one of many big changes wrought by the crisis, which when it finally runs its course will leave Central Europe's car industry looking fundamentally different.

In the shorter term, experts worry about what will happen once those measures taken by many EU governments, like the car-scrapping incentive scheme, run their course and are closed. "The measures taken by many EU governments had a large impact on demand in the last month. The big question is, what will happen after those schemes are closed? In some cases this will happen soon, and with the global recession being far from over, there is the risk of another drop in demand. The key factor is to overcome the crisis and bring back consumer confidence," says Ludek Niedermayer of Deloitte in Prague.

The problem for larger carmakers like Opel is that M&A is unlikely to play a big role, as it seldom does when times are so tough. "Most managements have made it abundantly clear that their priority is cash, and they have little intention of being drawn into auctions for assets which are suddenly surplus to current owners' plans," says John Lawson, an analyst with Citi Investment Research.

So what will happen to all those plants in Central Europe? Deloitte's Niedermayer says companies in the region offer an attractive mix of cost and quality. "But one should bear in mind that the industry includes strong foreign firms, innovative and competitive local firms, as well as firms mostly benefiting from lower costs but not being strong in research and innovations. Mainly the third ones could be under pressure."

Insolvency and factories auctioned off piecemeal or left empty is a possibility, though Central Europe's, as the lowest cost and most modern, have a better chance of staying open that their peers in Western Europe. "Loose" assets, such as Volvo Car, could fall into the hands of new entrants, perhaps Asian. "There is overcapacity in the global and also European markets. Some capacity reduction will take place, but in the Czech and Slovak republics I don't assume there will be the shut down of final production factories," says Niedermayer.

He adds, however, that "in the component business, the changes are frequent, even before the crisis hit." Private equity is expected to play a growing role in Central Europe's car parts sector, which has, unsurprisingly, proved extremely vulnerable to the slowdown because of weak capitalization, heavy exposure to the "Big 3" or extreme volatility of customer schedules, which gives them insufficient time to adjust costs.

Such conditions create the type of opportunities that private equity thrives on. In November, the Prague-based Benson Oak Capital announced the acquisition of 100% of BTV plast, a Czech producer of plastic parts for automobiles made by Skoda, amongst others. BTV will be merged with the two other automotive supply companies already in Benson Oak's investment portfolio: Liberec-based Plastkov MR and Hlinsko-based Plastkov Automotive, both of which also produce plastic parts for automobiles made in the Czech Republic. Together, the three companies had combined revenues of more than €72m in 2007 and employ about 1,600 people. "We are looking for companies that won't be able to service their customers on standalone basis. This is a form of defence, making ourselves bigger to cushion blows, but it's also an offensive move to build up long term and position ourselves for an exit. We want to be a consolidator in the market," says Robert Cohen, a partner with Benson Oak.

While Deloitte's Niedermayer accepts there are good opportunities to buy different kinds of assets now, with the demand for automotive products still unpredictable and access to financing is difficult, this will keep a lid on deals for the time being.

While there will certainly be less players in Central Europe's automotive industry due to consolidation, bankruptcy and moves to even lower-cost locations in Southeast Europe like Bulgaria or outside Europe altogether, what few are willing to countenance is the idea that the entire car industry is destined to exit the region. "Wages are increasing, but they lag behind those in Germany which is still producing cars. We still believe there's a viable sector here - I don't expect the industry to leave the region," Cohen says.

This view is shared by the consultancy BMI. Its analysts note that while German automotive parts manufacturer Bosch confirmed in February it would close its car stereo producing plant in Kecskemet, central Hungary, they believe Hungary will continue to be an attractive market for automakers and suppliers in the long term. "This view is supported by US-based auto components supplier BorgWarner's newly set up turbocharger manufacturing plant in Oroszlany, Hungary, where it will be looking to equip more than 50 car models for customers in Europe, China, India and Mexico."

Niedermayer insists that Central Europe offers a good mix of cost, quality and infrastructure for the car industry, "so unless there is huge downturn of the economy (and industry as well), I assume that these countries for some years to come will play an important role."

For now, though, it's a matter of hunkering down and riding out what is expected to be a rough few years. "I think the crisis in the car industry will last a long time, at least two years," sighs Woliszewski as he surveys his idled car parts factory.

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