Surviving tough economic times in auto recycling

Parts suppliers, such as LKQ, can not only survive, but prosper, in a recession.

According to economists in a recent Wall Street Journal forecasting survey, the United States economy is now in the midst of the worst part of a recession, but growth is expected to return by the second half of 2009.

Gregg Lemos-Stein, a credit rating analyst for Standard & Poor’s auto and auto supply group, covering major auto manufacturers and publicly traded auto recyclers had this to say: “Auto makers are in a very difficult position as are scrap metal businesses and all other suppliers closely tied to it, so all suppliers are facing hard conditions because some of their big customers are Ford, General Motors and Chrysler.

If your business is refurnishing parts from totaled vehicles and selling them in the aftermarket, relatively speaking, that’s a much better place to be in because they are not dependent on the production schedules of the major automakers.” He confirmed that every other area in the automotive business is being affected by the bad economy and lack of access to credit. Any kind of recycling and aftermarket business, compared to any other part of the automotive business, he believes is in a better business position right now. Lemos-Stein also confirmed that scrap steel prices, which are correlated to spot steel prices, have come down considerably since skyrocketing for much of 2008. “Spot steel prices often come down quicker than scrap. Same for recycled lead for batteries, it generally tracks the LME (London Metals Exchange) price of lead. Recycled metals over time generally track the same price of spot, but often with a lag. With metal prices so volatile, the challenge is to be quick to turn inventory to minimize risk to whatever degree possible,” he said.

With our economy reeling from the September financial crisis, many in the auto recycling industry have been given an unexpected, unwanted time-out to reassess their business plans. A severe, broadly-based economic turndown like this presents stiff challenges, but also opens up new opportunities for those savvy enough to adapt, survive, even prosper during a recession while others wither away and thin the competitive herd. Those who emerge intact on the next upward cycle will be smarter, stronger and poised for new growth.

Scrap metal prices that reached record highs last September dropped as a direct result of the Wall Street credit crisis. In early November east coast scrap prices showed signs of recovery and it is hoped that prices will rise as the stock market bottoms and begins to climb back, or as mills experience demand and raise prices. Many in the industry who deal in scrap metals have refocused efforts on recycled parts due to market demand and lower costs to acquire vehicles. Meanwhile, scrap yard managers look to control inventory, lower operating costs and conserve or raise cash to weather the economic storm.

J. Jeffrey Griffis, vice president at Dade Capital Corp., a provider of financing for the salvage, recycling and solid waste industries, noted increased volume in refinancing equipment. “Over the past few years and through most of 2008, many companies were selling scrap at record prices and making record profits. As a result they invested cash in new equipment. Recently, we have been very successful at financing the equipment that they paid cash for so they can get that money back to use for day-to-day operations.” Although the media sensationalizes the unavailability of credit, Griffis stated that his company has money readily available for commercial loans for equipment.

Griffis suggested one way to conserve capital is for business managers to have a discussion with their accountants. They need to make sure that they’re up to speed on the various tax incentives in the Economic Stimulus Act of 2008. It offers businesses a one-time depreciation tax deduction equal to 50 percent of the cost of specified kinds of new investments during 2008. Qualifying investments include tangible property, such as industrial or business equipment, expected to remain in use for less than 20 years. It also raises the limits on the value of new productive capital equipment and other property that businesses may exclude from their income as business expenses during 2008. Previously, the limit on expensable productive capital investments was $128,000, reduced (but not below zero) by the amount by which the value of those investments exceeded $510,000. The new law raises limits to $250,000 and $800,000 respectively. In addition, The Energy Improvement and Extension Act of 2008, signed into law in October as part of the $700 billion “bailout bill” provides accelerated depreciation for the purchase of new recycling equipment for up to 10 years.

Brad Giordano, sales manager for Giordano’s Recycling of Vineland, New Jersey confirmed that his company has seen the metals end of their business drop by 50 percent since the Wall Street crisis. Giordano’s has been in business since 1948 and has grown to become one of the top five recyclers in the New York-New Jersey-Philadelphia region. “Since our founding, we have survived many major economic turndowns. As a result of these experiences, we’ve become diversified in all aspects from non-ferrous, ferrous, plastic and waste papers. Our diversified sales and marketing ability will help us get through this. We’ll hold off on certain shipments until steel and other mills come back into the market or run into shortages and begin to raise prices,” Giordano said. Diversification is a wise way to spread risk even in the best of times.

Many recyclers deal in both scrap metal and recycled parts and as scrap prices tanked they have, by necessity, reemphazied on parts. Many see recycled parts as a bright hope during this recession. One is Bruce Luther, owner of Rock and Roll Auto Parts that operates in the San Francisco Bay area and processes approximately 250 autos a year. “When scrap peaked at $350 a ton, I was paying for older model cars and recycling them.” Now his primary focus is back to selling recycled parts.

Luther, who is both president of the State of California Auto Dismantlers Association and the San Francisco Bay Area Chapter, has seen recent, dramatic market changes. “The demand to get rid of end-of-life vehicles still exists. Instead of paying for old junkers, we now charge the consumer the cost of recycling. Right now it’s $150 per vehicle. When people call thinking they are going to get money for their car, that’s when I offer the option. Today, you have to be able to roll with the changes very quickly.”

Luther believes that because of tightening consumer credit, the slump in new car sales and households tight on cash, people will want to keep their old cars running. Demand for affordable, quality used parts have increased and will continue to grow. “I think our industry is in a very good position, not only to survive the recession, but profit from it.” Rock and Roll is economizing on operating costs, improving product quality and being an aggressive marketer with ads on local TV and newspapers and continuing its active word-of-mouth campaign. Since Rock and Roll is a family-owned business, it markets to family-owned gas stations, repair shops, bodyshops and dealerships. “I tell them that we need to work together to succeed. Please buy your parts from me rather than from the large, nationwide corporations. We take customers to ball games, hold picnics and build close personal relationships,” Luther said.

Quality is an important aspect of Rock and Roll’s plan. They do not sell dirty or damaged parts. All parts are washed, cleaned, tested, re-tested and come with a minimum warranty of six months or an extension up to one year for a few dollars extra. All parts are packed in fresh bubble pack and delivered in new cartons. The company put off plans to buy a new delivery truck, but instead replaced the 300,000 mile engine and transmission in their old truck and cleaned it up cosmetically. Other economies include energy savings by turning off lights, keeping thermostats down and greater use of hand-trucks rather than burning propane on forklifts.

Luther offered a suggestion. “Be active. Join an association. There’s strength in numbers. From every convention I have gone to – local, state or national – I bring back something that saves my business money or makes my business money. Everytime!”

LKQ Corporation, which provides replacement systems, components, and parts to repair cars and light trucks, expects revenues of approximately $2 billion for 2008, but is not immune to the turmoil in the financial markets. CEO Joe Holsten, believes there are characteristics of the industry that make it recessionary resistant. “The use of recycled auto parts offers a less costly alternative for car owners and insurance carriers. Our contacts in the insurance industry are telling us car owners are increasingly opting to resolve claims through cash settlements and manage the vehicle repairs themselves.”

Holsten also stated that insurance companies are finding controlling repair costs more important than ever before because investment returns have been hurt by the downturn in the capital markets and premium increases have not kept pace with inflation. “The volume of salvage cars available has been strong and helped us to build our inventory levels and improve our fulfillment rates. Despite higher operating costs, weaker used-vehicle demand has further helped us control price increases,” Holsten said.

Holsten emphasized that LKQ has a strong balance sheet, minimal debt and good liquidity to support company operations and fund growth. “In the long-run, we believe that current market conditions play toward our strengths. We anticipate that consumers will now be operating their vehicles for a longer period, and our product lines should aid them in their goal to achieve a lower cost of lifetime vehicle ownership.”