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Global Semiconductor Shortages Could Chip Away At The Auto Sector's Recovery In 2021

As the sophistication of in-vehicle electronics continues to accelerate, the auto industry is increasingly reliant on semiconductor devices as a critical component in automobile manufacturing. The increasing use of semiconductors in cars has enabled a broad suite of new functionalities, including in-vehicle connectivity, driver-assist safety technologies, navigation, infotainment, and battery management systems used in electronic and hybrid vehicles (see "Steady Global Auto Industry And Higher Tech Content Spur Growth In Technology Companies," Dec. 17, 2015).

Semiconductor sub-suppliers--foundry partners and packaging manufacturers--had already scaled back capacity investments in 2018 and 2019, when demand was slowing and volumes were flat in most regions. Then, the pandemic-linked auto production shutdown in March and April 2020 led manufacturers to drastically reduce their orders from semiconductor suppliers. As a result, most semiconductor manufacturers cut auto chip production. At the same time, they ramped up production of chips for smartphones, gaming systems, and consumer electronics, the demand for which surged as consumers sought more in-home entertainment options during the COVID-19 pandemic. Many of the chips for consumer products also command higher margins than those for automobiles, which generally do not use the most advanced manufacturing techniques due to the automotive market's greater reliability and safety requirements.

A further squeeze to the global supply occurred in late September, when the U.S. Commerce Department set regulations (the Export Administration Regulations) that restrict the export of certain semiconductor equipment or components to a list of Chinese firms, including China's largest foundry player, Semiconductor Manufacturing International Corp. (SMIC). In parallel, the global auto industry recovered meaningfully faster than expected in the second half of 2020, after being considerably tight in terms of inventory earlier in the year, creating a shortage in semiconductors.

The Semiconductor Shortage's Effect On Our 2021 Auto Recovery Assumptions

We estimate that so far, the overall impact of shortages related to publicly announced production shutdowns equates to under 5% of global quarterly production. Some automakers could face up to a 20% production shortfall in the first half of 2021, as many plants are operating at lower utilization, and many more could be affected over the next quarter or two before supply normalizes. We expect that a large chunk of the lost production will be recovered in the second half of the year. However, we still expect this could result in a net loss of production of up to 3 million units (roughly 3-5% of global production) in 2021. The impact on sales will vary depending on which semiconductor company the automaker buys from, as some automakers and chipmakers seem to have started 2021 with higher inventories than others. For example, Japan's Denso stated this chip shortage will not affect its production over the next six months.

Recovery of lost production in the second half is dependent on new capacity that will come online and the willingness of automakers to pay higher prices for chips. The risk of increased cost pressure will add another challenge to the industry, the margins of which have already been battered by erosion linked to increased costs related to the electrification of vehicles.

We will reassess and publish our revised base case in March after getting a better understanding of the magnitude of the possible volume impact for the full year. Our current base case (see "Industry Top Trends 2021--Autos," Dec. 10, 2020) assumes global light-vehicle sales will improve 6%-8% year-over-year after a 15% drop in 2020. We expect U.S. light-vehicle sales to rise by 10%-15% year-over-year to over 16 million in 2021 before stabilizing to over 16.5 million in 2022. However, we believe there are increasing downside risks to our base case for U.S. sales, as affordability continues to be a risk. Moreover, the semiconductor shortage will lead to some supply disruption and possibly lower retail availability of many models over the next couple of quarters (see "After Ending 2020 Strongly, U.S. Auto Sales Are Set To Continue Recovery In 2021," Jan. 19, 2021).

In Europe we expect a relatively timid recovery in 2021 (6%-8%) after a 21% decline last year. Despite more subdued demand compared to other markets, we believe that due to the all-time low inventory level in the region, the impact of the semi shortage will be felt in the first and possibly the second and third quarters.

Announced Production Cuts By Auto OEMS
OEM Rating as of Feb. 9, 2021 Comments/production cuts

Daimler AG

BBB+/Stable Daimler announced that it would reduce production in two factories in Rastatt and Bremen (and noted the possibility for further production cuts in February). IHS estimates that the Rastatt plant will produce 328,000 vehicles in 2021 and the Bremen plant will produce 313,000 vehicles (6,000-6,500 vehicles per week in each plant).

Ford Motor Co.

BB+/Negative Ford initially had stated that it idled its Louisville Kentucky plant (Escape and Lincoln Corsair models). IHS estimates that the Louisville plant would produce about 255,000 vehicles in 2021 (4,500-5,000 per week). In addition, Ford will idle its Focus plant in Sarrlouis Germany for one month (until Feb. 19). IHS estimates fiscal-year 2021 production from the Saarlouis plant would have been 189,000 units (3,500-4,00 per week). The company also has temporarily idled two shifts at its Chicago Assembly Plant (Ford Explorer and Lincoln Aviator).

General Motors Co.

BBB/Negative General Motors plans to idle three North American plants: Fairfax, Kansas (Chevrolet Malibu sedan and Cadillac XT4 sport-utility vehicle. ); Ingersoll, Ontario (Equinox SUV); and San Luis Potosi, Mexico (Equinox, GMC Terrain, and Chevy Trax). It will operate its plant in Bupyeong, South Korea, at half its usual production capacity. Other products affected: Cadillac XT4, Chevrolet’s Malibu, Equinox and Trax, the Buick Encore, Holden Trax and the Opel/Vauxhall Mokka.

Honda Motor Co. Ltd.

A-/Negative According to reports, the company planned to reduce production by 4,000 vehicles in January. In addition, it stopped production at Swindon from Jan. 18. to Jan. 22. In February, the company plans on shutting down a Mie plant for five days, which makes the Fit and N-Box model. In North America, the company also plans on reducing production in five plants which will result in reduced production of the Accord, Civic, Insight sedans, Odyssey minivan, and Acura RDX.

Nissan Motor Co. Ltd.

BBB-/Negative Reduced production of the Note model at its Oppama plant in Japan. Also suspended some truck production in Mississippi.

Stellantis N.V. (Fiat Chrysler Automobiles)

BBB-/Stable FCA stated that it would idle its plants in Ontario, Canada (where it builds the Chrysler 300, Dodge Charger and Dodge Challenger) and Toluca, Mexico (where it builds the Jeep Compass). IHS estimates that the Ontario/Toluca plants would manufacture 168,000/123,000 vehicles in 2021 (3,00-3,500/2,000-2,500 per week)

Toyota Motor Corp.

A+/Negative Cutting production of the Tundra by 40% in its San Antonio plant. IHS estimates that Toyota would have manufactured about 138,000 Tundras in the San Antonio plant in 2021 (about 2,500-3,000 per week). There was also a production disruption at its plant in Guangzhou, China.

Volkswagen AG

BBB+/Negative VW announced reductions, including for the Golf, in December 2020. The company announced further production cuts on Jan. 13, 2021, for its Wolfsburg plant in Northern Germany, and it stated it would reduce working hours for staff producing the Tiguan, Touran, and Seat's Tarracco models. Shortages to negatively affect the VW brand in calendar-year 2021 by 100,000 units (additional impacts to the company's other brands).

The Impact Will Vary By Region And Automaker, But Cash Flow Will Be Weaker For Some Over Next Two Quarters

We believe the shortage could take two to three quarters to resolve for most global automakers and up to a year for select models. Ford estimates that it may have to reduce its first-quarter production by 10%-20% due to a lack of chips. If this shortage extends to the second quarter, it would likely decrease the company's full-year adjusted EBIT by $1.0 billion-$2.5 billion, net of reasonable cost recoveries and some production makeup in the second half of the year. We expect roughly similar exposures for General Motors and FCA production shortfalls as well. Volkswagen expects a loss of approximately 4%-5% of its production in the first quarter; assuming that normalization could take up to nine months, the overall impact would not be substantially different from that of other automakers.

As a result, there is potential for significantly weaker free cash flow in upcoming quarters related to the unwinding of working capital related to production stoppages, before improving toward the end of the year. Per IHS, the biggest volume disruption is in Mainland China, whereby based on available information, the risk could be close to 250,000 units in the first quarter.

Typically, there's six to nine months of lead time for the industry (from order to delivery) to get chips, given the complex supply chain. In our understanding these lead times currently are longer by up to two months for all chips. In general, back-end equipment for new tools can typically be procured in roughly four weeks, while acquiring front-end equipment can typically take one to two quarters. The demand/supply imbalance will likely take longer to resolve in this case, as the chip shortage isn't limited to the auto end market; it's affecting the industrial, data center, communications, and consumer segments as well. Still, the impact to autos might be most severe given the sharper recovery in recent quarters. And more importantly, the existing chip manufacturing capacity has already been procured by customers in other end markets.

Based on comments from large Tier-1 automotive suppliers like Robert Bosch, the shortage is particularly severe in parts used for engine and transmission control units. As these components are specialized for automotive applications with a comparatively small market, we expect foundries will prioritize production on higher-volume, higher-margin chips in other end markets, which are also facing supply shortages. Foundries are increasing capital spending in response to industry conditions, and some have publicly commented that a portion of this investment will be focused on relieving pressure on the auto supply chain. Nevertheless, we expect supply to remain constrained through the first half of 2021 and prices to increase over the short term as suppliers allocate what capacity they have.

The Impact On Semiconductor Firms Should Be Limited

The unexpected recovery in the auto market certainly caught semiconductor firms off guard. The confluence of global macroeconomic improvement, IT spending growth, and the strong demand for smartphones, PCs, gaming consoles and other consumer electronics or enterprise hardware products prevent foundries from materially reallocating manufacturing capacity to stem the auto semiconductor component shortage. Increased supply likely won't arrive until the second half of 2021, and semiconductor firms are dynamically adjusting their pricing, inventory levels, and vendor programs to meet the market needs.

Below are key takeaways from semiconductor firms with significant auto-end market exposures:

Foundries

Taiwan Semiconductor Manufacturing Co. Ltd. (TSMC), a major supplier of chips, boosted its spending to a staggering $28 billion for 2021 from $17.2 billion in 2020. However, only 3% of its 2020 sales were for auto end markets, whereas 48% were for smartphones, and 33% were for high-performance chips. In addition, we believe that the spending will be mostly for capacity using most advanced technology, without materially increasing the mature process capacity used for auto chips. TSMC has pledged to expedite products through its wafer fabs and reallocate wafer capacity to support the auto industry. Nonetheless, we believe the company is unlikely to quickly allocate significant capacity using mature process technology for the production of auto chips before fulfilling its existing commitment, given the current short supply.

SMIC operates the largest China-based semiconductor foundry. The U.S. Commerce Department recently added SMIC--along with dozens of other Chinese companies--to its Entity List, in addition to having previously applied the Export Administration Regulations to SMIC's U.S. supply chain in late September. These measures effectively cut the company off from U.S. suppliers, removing a potential source of capacity for the company and limiting its ability to shift capacity between chip products.

Semiconductor manufacturers

Infineon Technologies AG has been the leader in the automotive semiconductor market by revenues following its acquisition of Cypress Semiconductor.

We believe Infineon might face some short-term issues for certain microcontrollers that are outsourced to foundries. At the same time, we do not expect that the company will be able to benefit from the current industrywide supply shortage, as its internal manufacturing production focuses on more complex and differentiated products rather than the predominantly standardized products used in autos and are most affected by the shortage.

NXP Semiconductors N.V.'s auto segment, which contributed 44% of total revenues in 2020, was up 9% year-over-year during the fourth quarter of 2020. It's expected to be up in the mid-20% area on a year-over-year basis in first-quarter 2021 as order rates continue to accelerate and demand remains strong in ADAS, digital clusters, and electrification. The company's inventory level continues to dip as it balances meeting customer demands and maintaining adequate inventory levels. More recently, NXP--as well as Japan's Renesas Electronics and other chipmakers--have announced price increases as the industry confronts soaring demand and tight foundry capacity.

Microchip Technology Inc.'s auto end market exposure is about 20% of total revenues. The company believes the supply tightness could last through most of 2021 or into 2022 as a result of the low distributor-channel inventory and wafer fab and back-end manufacturing constraints observed in the marketplace. Given the extended lead times for many of its products and higher material and subcontractor manufacturing costs, Microchip announced the following steps: (1) To discourage excessive ordering, it adjusted its customer order policy by changing terms for cancellation and delays to up to 90 days from 45 days. (2) The company is passing through higher input costs to customers. (3) It has implemented a preferred supply program, giving priority to customers willing to place 12 months of non-cancellable orders in return for higher priority treatment. While any upside might be capped by supply constraints, Microchip's March 2021 quarter and 2021 guidance anticipate good revenue growth.

Texas Instruments Inc. generates about 20% of revenues from the automotive sector. The firm reported an exceptionally strong rebound in demand for automotive products in the December quarter, with revenues up 25% year over year after a steep trough in the June quarter. Management believes that it has sufficient capacity to meet industry demands internally and has stated that it does not plan any major pricing changes.

Downside Pressure To Our Automaker Margin Assumptions Will Persist

We expect the industry to operate with less than optimal capacity, resulting in lower inventories than planned in the first half of 2021. For instance, U.S. light vehicle inventories (at dealerships) at the end of 2020 remained lower than 2019 levels. Moreover, it could take time to fully replenish vehicle stock due to strong demand (especially for pickups) as well as semiconductor chips shortages. Pickup truck inventory at dealer lots remains low (December pickup truck inventory supply was 37 days, down from 48 days in November and from 69 days in December 2019). Automakers will adjust by shifting production from slower-selling vehicles (such as sedans in the U.S.) to divert the chips to hotter segments of the market, including pickup trucks and SUVs. In Europe, producers might have time to replenish their low inventories at year-end 2020, as ongoing restrictive measures could keep demand subdued. We also expect that automaker profit margins will not weaken directly as a result of these supply disruptions, as they will lower incentives to offset the tighter supply.

In our forecast for 2021-2022, we've incorporated modest headwinds that would limit EBITDA margin improvement (that is typically tied to volume recovery) for most automakers and Tier 1 auto suppliers to account for:

  • Restructuring expenses related to plant closures;
  • Rising commodity costs;
  • Large engineering expenses for developing autonomous and electrification-related technologies; and
  • Elevated pricing pressure in several key markets, albeit offset by some tailwinds due to some inventory shortages which could help support prices for some models.

We still assume that credit quality within the sector will improve somewhat in 2021 compared to 2020 because of better factory utilization and a more favorable product mix than in previous years. Overall, we don't expect the level of sales in our current 2021-2022 base case to be the direct trigger for any downgrades this year. One reason is that these levels are healthy enough for most automakers and suppliers to operate with relatively strong EBITDA margins, especially given the higher profits they earn on trucks. In addition, even though gas prices are rising, we believe significant new product launches--along with better fuel efficiency, higher perceived safety for trucks, and steady incentives--will support automakers' current product mix; trucks accounted for 76% of sales last year. At the same time, low interest rates--coupled with likely persistence of incentives for alternative powertrains in Europe--will contribute to the good momentum of battery and hybrids. However, given the modest impact to sales and broader vaccine rollout uncertainties, we expect OEMs and suppliers to provide cautious outlooks for 2021.

The Impact On Supply-Chain Decisions Should Be Limited

As supply chains have grown more complex, it has become increasingly difficult for manufacturers to keep pace. The crisis has yet again exposed the perils of forecasting demand and managing supply during disruptions (see "Strong Connections Or Weak Links: How Global Supply Chains Affect Credit Quality," Oct. 4, 2011). It also raises some troubling questions for the automotive industry, which will become even more reliant on chips as electric vehicles grow in popularity and autonomous driving develops. Although EVs only make up 3% of global light vehicle sales, the semiconductor content of electric vehicles is roughly three times more valuable than that of a petrol car, according to IHS Markit.

Electrification remains the industry's pivotal challenge over the next five years, with Europe and China aiming for 20% of light-vehicle sales to be electric vehicles by 2025. The rate of electric vehicle adoption in the U.S. could be roughly only 10% by 2025, as low gas prices and reduced tax incentives limit EV purchases. However, with the election of Joseph Biden, the new administration's agenda for clean energy could impose stricter fuel-economy standards, thereby speeding up the shift toward zero-emissions. Some carmakers and automotive chip specialists could decide to take more manufacturing in-house.

In our analysis of the industry, we will look favorably on automakers that take steps to avoid a repeat of the crisis, such as by bypassing large suppliers and developing closer relationships with chipmakers themselves. The two sectors will likely work more closely to align trends and forecasts, and we will watch whether this results in rising inventory at Tier 1 suppliers. Over the next few years, our analytical focus will also be on future potential disruptions from shortages in lithium, cobalt, nickel, graphite, and related rare-earth materials involved in battery production.

Related Research

This report does not constitute a rating action.

Primary Credit Analyst:Nishit K Madlani, New York + 1 (212) 438 4070;
nishit.madlani@spglobal.com
Secondary Contacts:David T Tsui, CFA, CPA, San Francisco + 1 415-371-5063;
david.tsui@spglobal.com
Vittoria Ferraris, Milan + 390272111207;
vittoria.ferraris@spglobal.com
James W Thomas, New York + (212) 438-0181;
james.w.thomas@spglobal.com
Lawrence Orlowski, CFA, New York + 1 (212) 438 7800;
lawrence.orlowski@spglobal.com
Research Assistant:Suraj Rajani, Mumbai

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