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Auto suppliers see spike in probability of default during COVID-19 pandemic


According to Market Intelligence, December 2022


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Auto suppliers see spike in probability of default during COVID-19 pandemic

The odds of default for auto parts suppliers jumped in April, and experts expect increased consolidation and bankruptcies within the industry as the coronavirus pandemic continues to hammer global new vehicle production.

S&P Global Market Intelligence's median one-year market signal probability of default rose to above 20% for auto parts and equipment suppliers in April, up from below 5% at the beginning of 2020. For tire and rubber suppliers, the probability of default rose above 15% in April, up from below 5% in January. The figure represents the odds that a company will default on its debt within the next year based on fluctuations in the company's share price and other country and industry-related risks.

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While the odds of default both for industries have fallen slightly from the initial spikes in early April, suppliers continue to feel the same pain as the automakers to which they sell amid a global drop in demand for new vehicles and slowdowns in production.

Automakers including General Motors Co., Ford Motor Co., Nissan Motor Co. Ltd. and Daimler AG saw the industry's default odds rise to above 20% in April from less than 5% at the beginning of the year. Meanwhile, suppliers such as Sumitomo Electric Industries Ltd., Valeo SA and Hyundai Mobis Co.Ltd. showed the greatest risk of default among their peers.

The auto supply industry is likely to see an increase in bankruptcies and consolidations because of the pandemic, said Wally Hopp, professor and associate dean at the University of Michigan's Ross School of Business. Financial issues stemming from the pandemic could last for years for suppliers as they deal with labor issues, shutdowns and disruptions from their own suppliers, Hopp said.

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Small and medium suppliers with less ready access to credit will be hardest hit, Hopp said, adding that these companies are likely to file for Chapter 11 bankruptcy to stay open or to sell assets.

"I would not be surprised to see some of the major [original equipment manufacturers] encourage their Tier 1 suppliers to buy up some of these distressed assets as a means for further consolidation of the industry as a way to facilitate the capex investments needed to make the shift toward new technologies, such as electrification and autonomous vehicles," Hopp said.

Large integrated companies with enough assets to weather financial storms and invest in technology are better off in times like these, he said, whereas smaller, independent suppliers were already under stress.

"This crisis will certainly push some of them over the edge," Hopp added.

Meanwhile, global light-vehicle sales are expected to fall 22% in 2020 compared with 2019 because of the pandemic, according to IHS Markit. The analytics firm expects sales of about 70.3 million vehicles in 2020, down from the previous forecast of 88.8 million.

Hopp said the forecasts call for a sudden drop in 2020, even larger than the decline during the 2008-2009 financial crisis.

The largest auto suppliers with more cash and access to credit lines can weather the crisis, assuming plants reopen soon, according to Morningstar analyst David Whiston.

Magna International Inc., one of the top auto suppliers, already increased the size of its revolving credit facility to $1 billion from $330 million with a maturity date of April 12, 2021, instead of June 2020. German auto parts manufacturer Continental AG said it had cash and cash equivalents of more than €2.5 billion and committed unused credit lines of more than €4.3 billion, as of March 31. Continental has said dozens of its more than 2,000 suppliers are under financial duress, according to the Financial Times.

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The top five auto suppliers with the highest one-year probability of default scores as of April 28 are Sumitomo Electric Industries Ltd. At 30.7%, Valeo SA at 28.9%, Hyundai Mobis Co. Ltd. at 26.1%, HELLA GmbH & Co. KGaA at 23.7% and HUAYU Automotive Systems Co. Ltd. at 20%, according to Market Intelligence.

The two-year probability of default increases for the five companies, with Sumitomo at 36.6%, Valeo at 34.8%, Hyundai Mobis at 31.8%, Hella GmbH & Co. at 29.3% and HUAYU at 25.4%, according to the data.

Magna International, meanwhile, has a one-year probability of default score of 12.7% and a two-year score of 17.3%. Continental has a one-year score of 17.9% and a two-year score of 23.1%, according to Market Intelligence.

Suppliers that had lower debt and leverage levels before the pandemic — including Magna International and auto technology company Gentex Corp. — are better positioned to survive the crisis, said Garrett Nelson, senior equity analyst at CFRA Research.

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Policymakers also want to keep the auto industry afloat, but that usually means the major automakers, not the suppliers, said Joseph Foudy, an economics professor at New York University's Stern School of Business.

As a result, suppliers that will "be squeezed inevitably by the major OEMs who are just desperate for money" face more risk, he said.

CFRA's Nelson noted there were bankruptcies across both auto supplier and manufacturer subindustries during the financial crisis in 2008-2009, including automakers GM and Chrysler, along with suppliers such as Lear Corp. and Visteon Corp.