Brighter Signs Emerge For Automotive Deals

The automotive industry may be poised to fight its way back from a three-year sales slump. Reports from the front lines of the manufacturing economy and from credit analysts are showing some signs of strengthening in the beleaguered industry.

But even the industry’s backers caution that the delicate recovery now taking shape could collapse unless the economy continues to grow. Michael Psaros, a co-founder and managing partner of KPS Capital Partners LP, said his firm’s portfolio company, HHI Group Holdings LLC, has seen “a material pickup” in demand since last November as both domestic carmakers and the U.S. units of foreign makers have stepped up their orders for parts.

Created by KPS in September 2005, HHI has become a platform for five operating companies—Jernberg Holdings LLC, Impact Forge Group LLC, HHI FormTech LLC, Kyklos Bearing International LLC and Cloyes Gear and Products Inc—to form what is, among other things, the largest independent manufacturer of forged parts for the North American automotive industry.

The fundamentals are in place for a resurgence in car buying, Psaros said on March 1 at the Reuters 2010 Private Equity and Hedge Funds Summit in New York (Reuters is the publisher of Buyouts). For instance, Psaros noted that the auto industry sold only 9 million units last year, compared to 12 million cars that were scrapped, suggesting pent-up demand for new cars.

Other signs also are encouraging. Moody’s Investors Service raised its corporate family rating March 1 on American Axle And Manufacturing Holdings Inc. to ‘Caa1’ from ‘Caa2’. The upgrade to the parts supplier, a former Blackstone Group holding, was based on the company deleveraging its financial profile as conditions improve for the North American automotive industry, Moody’s said. Standard & Poor’s Ratings Services, meantime, raised its corporate credit rating on American Axle on Feb. 17 to ‘B-‘ from ‘CCC+.’

“Supporting this view is our assumption that light-vehicle production in North America is starting to recover,” wrote S&P credit analyst Lawrence Orlowski, noting the company’s improved liquidity and overall financial performance in the fourth quarter. “We believe American Axle is capable of generating some positive free cash flow in 2010.”

But even those who see the signs are concerned about the future of the economy, and what that means for the industry. “I can’t tell you how worried I continue to be,” Psaros said, citing the Federal Reserve’s extensive support for credit markets over the past year. Psaros said he believes there is greater than a 50 percent chance of a double dip recession.

“I don’t think there is sufficient consumer-driven demand to run with the football,” he said. Indeed, the potential expiration of the Bush tax cuts at the end of 2010 represent what Psaros called “the biggest tax increase in the history of the republic.” Although the higher taxes would affect only households with more than $250,000 income, he argued those are the ones that are driving consumption today.

“The only people who are spending money in this economy are going to take a huge tax increase,” Psaros said. And with other legislative initiatives, such as health care reform and the prospect of “cap and trade” legislation for pollution control, Psaros said, “Washington has created so much uncertainty that it has essentially frozen the economy in place.”