Description

The wheels are falling of the U.S. auto industry’s cart and Superior Industries International makes the wheels. I believe four events make Superior a good short: 1. falling unit sales in the U.S.; 2. a dramatic drop off in sales of larger vehicles that use larger, more profitable wheels; 3. the credit crisis is lowering the purchasing power of consumers; and 4. rising costs in an industry that must plan capacity and production cycles years in advance.

Background (from Superior’s 10-K)

Superior supplies approximately 30% – 35% of the aluminum wheels installed in passenger cars and light trucks in North America, with wheel manufacturing operations in the United States, Mexico and Hungary. The Company entered the aluminum wheel market in 1973 and their initial production of an aluminum road wheel for a North American customer was a Mustang wheel for Ford Motor Company. In 1990 Superior entered into a marketing joint venture with Topy Industries, Limited (Topy-Superior Limited (TSL)), Japan's largest wheel manufacturer. TSL markets Superior’s wheels to Japanese OEM customers with plants in Japan and in the United States. In 2007, TSL had agreements to provide 34 wheel programs being manufactured in our facilities for delivery to Japanese customers. Superior currently sells its aluminum road wheels to Ford, General Motors, Chrysler, Audi, BMW, Fiat, Jaguar, Land Rover, Mazda, Mercedes Benz, Mitsubishi, Nissan, Seat, Skoda, Subaru, Suzuki, Toyota, Volkswagen and Volvo.

Sales to GM, as a percentage of consolidated net sales, were 36 percent in 2007, and 37 percent in 2006 and 2005. Sales to Ford, as a percentage of consolidated net sales, were 33 percent in 2007, 34 percent in 2006 and 33 percent in 2005. Sales to Chrysler LLC, as a percentage of consolidated net sales, were 13 percent in 2007, and 15 percent in 2006 and 2005. Combined, GM, Ford and Chrysler accounted for 82% of fiscal 2007 sales.

Superior is a very well run company and has a strong balance sheet with $105 million in cash and no debt, a rarity in the heavily indebted automotive space. So, why short it? And, why short it after at this point?

Because being the best swimmer in the Titanic will not do much without a lifeboat and lifeboats are far away at the moment. The Detroit 3, which constitute over 80% of Superior’s sales, have seen truck sales hit the iceberg of higher gas prices, a slower economy and cash strapped consumers and banks that can no longer afford to finance purchases of cars.

Exhibit A: The Sinking Detroit 3

U.S. July Sales 2008 2007 2006 2005

Detroit 3: Total Vehicles 485,370 630,348 777,949 1,105,009

Truck Sales 298,640 427,068 508,412 816,101

GM 127,600 196,004 244,095 354,846

Ford 98,770 126,377 143,236 259,381

Chrysler, LLC 72,270 104,687 121,081 201,874

Consumers are responding to the higher gas prices and a slower economy. While overall auto sales are down 23% and 56% from 2007 and 2005 respectively, truck sales are down 30% and 63% from 2007 and 2005. July sales clearly show how consumers are responding to higher gas prices by switching to more fuel efficient vehicles.

Light trucks have been the profit makers for the Detroit 3 (no longer the Big Three as they have lost too much market share to foreign rivals), but the same is true for wheel suppliers. Superior has not directly addressed the issue, but other wheel vendors have acknowledged that they have been willing to lose money on the wheels sold into smaller car programs figuring they will make it up on the bigger wheel programs used on light trucks. This worked for the OEMs and the suppliers while the U.S. consumer was buying trucks, but is now a recipe for disaster. It is no wonder the shares of GM and Ford are selling at multi-decade lows.

The credit crisis has spread to auto loans hurting the purchasing power of consumers. Default rates are climbing higher and residual values for big ticket SUVs and trucks have are plunging, causing losses for the companies financing the leases since the leaser owns the car and the lease payments may not be enough to pay for the actual depreciation of the vehicle leased. Lender nervousness torpedoed Chrysler Financial’s August fund raising round. It was only able to raise $24 billion out of the $30 billion it was seeking. This forced Chrysler to cancel its leasing program and Ford and GM are likely to lower their activity in the space as well which could hurt sales to unit “sales” as consumers addicted to fancy cars for a low monthly payment will have to settle for cheaper cars or delay purchases of new cars.

As a supplier to the Detroit 3, the standard modus operandi is that every year, even in long-term contract, the supplier must lower costs or lose the business. This is particularly punishing in an environment where the Mexican peso has appreciated 9% year-to-date (through 8/5/08) and natural gas and aluminum prices have

Forging aluminum into wheels is an intensive industrial process which requires the maker to accurately forecast where demand will be three years out and plan its production capacity accordingly. It is unlikely that Superior was able to predict the current shortfall in production, especially since its customers were caught flat footed. In their last quarterly conference call management stated that margins benefited from product mix which favored larger wheels and singled out Acadia sales as being “gangbusters”, yet July sales of Acadias were down 5% and Outlooks (the Saturn equivalent) were down 29% on a year-over-year basis. So far, Superior’s stock has outperformed its peers due to its strong balance sheet and continuous market share over the last few years that is now slowing down. Now its operational results will be driven by market conditions and those are not favorable. With high fixed costs, falling sales and unfavorable product mix Superior will soon be losing money and investors will be bailing out.

Catalyst