Another rough year may be ahead for auto suppliers

It's already shaping up to be another bumpy year for parts suppliers as they get the financial squeeze from inflation and rising interest rates while navigating uncertainty in the economy and the new-vehicle market.

"The squeeze is really being applied to suppliers right now because of the drop in sales volumes, as well as the rising raw material and labor costs that continue," said Paul Carrannanto, a principal in the industrial manufacturing and automotive sector for PwC.

The number of suppliers in financial distress spiked in 2022 as those issues cut into margins and sent companies scrambling for price relief from their customers.

According to a PwC analysis, 42 percent of suppliers reported some level of financial distress in the first half of 2022, up from 27 percent in 2021. That figure nearly matches the 45 percent of suppliers who reported financial distress in 2020 when the first wave of the COVID-19 pandemic shut down auto manufacturing.

A convergence of factors made 2022 a difficult year for parts companies, even as their automaker customers reported sizable profits. The microchip shortage continued into its second year, shaving millions of vehicles off production schedules and cutting supplier volumes.

The troubles promise to come to light in upcoming days as publicly traded suppliers report fourth-quarter and 2022 earnings results.

Unstable commodity pricing and rising interest rates raised business costs for suppliers, some of whom sought pricing relief and changes to their contracts with customers. And a host of regional challenges, most notably the war in Ukraine, created further supply chain uncertainty.

Inflation and the microchip shortage have shown signs of easing in the opening weeks of 2023, but those situations are expected to continue well into the year, said Michael Robinet, executive director of automotive advisory services at S&P Global Mobility.

"Instead of an on-off switch, it's a dimmer switch," he said. "The chip situation has gotten somewhat better and that will probably continue. But to think we're completely out of the woods is a bit Pollyannaish."

Given the persistence of those issues — and given heightened economic uncertainty — suppliers have indicated they are preparing for a variety of scenarios to play out in 2023.

In an interview with Automotive News this month, Marelli CEO David Slump said he expects the first half of the year to be difficult for the industry, but conditions could improve in the back half. Marelli, which went through a court-led restructuring in 2022, ranks No. 20 on the Automotive News list of the world's largest auto suppliers.

"The second half is my question," he said. "With pent-up demand and a potential soft landing in the U.S., there's a scenario where the second half could pick up, particularly in North America. Or it'll feel tough all year. We're preparing for both."

Likewise, Forvia CEO Patrick Koller said the world's seventh-largest supplier is preparing for a wide range of scenarios.

He pointed to the war in Ukraine as a major source of uncertainty, with outcomes ranging from the war's end to a major escalation, with each having a significant impact on the auto industry.

"The only thing we can do is to get ready, no matter what the scenario might be," Koller said during a news conference this month.

Suppliers have been dealing with one operating crisis after another since 2019, when the UAW's strike against General Motors in the U.S. created major planning and financial ripples throughout the supply chain.

Since then, companies have dealt with the pandemic, higher prices for energy and raw materials, labor shortages, complications in logistics, factory shutdowns in China, production interruptions at subtier parts factories and market uncertainty over how quickly automakers will roll out new electric vehicles or wind down legacy internal combustion programs.

"This coming fourth quarter, we will have basically been in this situation for four years," Robinet said. "That respite that a lot of suppliers hoped for as volumes came back — they just haven't had that kind of relief. It's been calamity after calamity after calamity."

But PwC's Carrannanto said that suppliers can navigate this period of uncertainty and emerge stronger than they were when they entered it in 2019. He said firms should use this year to focus on ways to improve liquidity and profitability while keeping their long-term focus on making sure they are set up well for the era of electrification and connectivity.

"Any supplier can certainly benefit if they make the right moves in their portfolio and their footprint to be more flexible and come out of the recessionary pressures in a stronger and more profitable position," he said.

He predicted that a large number of mergers and acquisitions will likely occur over the next year, particularly in areas related to EVs, electronics and software. Given the financial distress many companies find themselves in, there could be some value buys to be had for companies looking to bolster their positions in those areas, he said.

"Now is the time to rethink your portfolio and your capacity to see if you can create more value in this time frame," Carrannanto said.

The past few years have driven home the importance of being nimble and flexible, Robinet said.

"There's just a lot going on," he said. "There's more than just one significant issue that these suppliers need to deal with at one time."