Germany’s auto parts sector: defaults point to consolidation in cyclical downturn rather than crisis
      WEDNESDAY, 10/04/2024 - Scope Ratings GmbH
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      Germany’s auto parts sector: defaults point to consolidation in cyclical downturn rather than crisis

      Multiple bankruptcies in Germany’s automotive parts sector since mid-2023 are less a sign of a sector-wide crisis than the impact of a cyclical downturn and tight credit conditions on suppliers with financial and commercial weaknesses.

      By Georges Dieng and Gennadij Kremer, Corporate Ratings

      To be sure, the series of recent corporate defaults observed in Germany is unsettling. Since June last year, Allgaier GmbH, Eisenwerk Hasenclever & Sohn GmbH, Eismann Automotive GmbH, HAL Automotive Plauen GmbH, Kamei GmbH, Philippine Technische Kunststoffe GmbH and SD Automotive GmbH have filed for bankruptcy, making headlines and putting thousands of jobs in the sector at risk. Across the border in Austria, MGG Herzogenburg GmbH has also gone bankrupt.

      However, investors should not draw hasty conclusions and extrapolate this wave of insolvencies to the entire European auto parts industry. Serious as it is, the current situation should not be confused with the systemic shock that the industry encountered during the global financial crisis and the Covid pandemic when demand collapsed and the industry faced supply-chain bottlenecks.

      Germany’s larger auto parts suppliers are adapting more successfully to weak demand and structural changes in the industry with the shift to electric-power trains and software-rich vehicle design.

      After the post-pandemic catch-up in 2023, automotive demand is globally more subdued this year due to slowing economic growth, declining consumer confidence and heightened geopolitical risks.

      In Germany, against the backdrop of a sluggish economy, a small decline in vehicle registrations and production (flat to -1% according to the industry body VDA) is to be expected. This cyclical slowdown is far from dramatic, in the context of the 15% recovery (compound annual growth rate) in German car production in 2021-23 and the earlier secular decline after output peaked in 2011 (Figure 1).

      Figure 1: German passenger car production: recovery stalls after post-Covid rebound

      Source: VDA, KBA

      Lower orders, OEM cost-cutting weigh down on SMEs in sector

      Auto parts makers recently at risk tend to be small and medium-sized enterprises (SMEs), concentrated in Germany. These companies belong to the “Mittelstand” of small, typically family-owned businesses which form the backbone of the German automotive supplier industry.

      These firms have proved particularly vulnerable to, first, the cyclical downturn in the auto industry (Figure 2), visible in the decline in incoming orders since Q2 2023; secondly, the weakening German economy marked by relatively high inflation, tighter credit conditions, shrinking industrial output; and thirdly, increased pressure from original equipment manufacturers (OEMs), including more insourcing of parts/components manufacturing and accelerated production relocation to cheaper countries (Eastern Europe).

      Figure 2: Vehicle sales yet to regain pre-pandemic levels: sales in China, US, Europe 2018-24E

      Sources: ACEA, CPCA, GlobalData, VDA   Note: Europe 30 = EU plus EFTA, UK

      Tight financing conditions aggravate pressures facing smaller, indebted suppliers

      Since 2021, the balance of power between suppliers and OEMs has shifted in favour of the latter, with increasing pressure on suppliers’ margins, especially for smaller firms. To make things worse, German OEMs are chasing cost savings hard in response to fiercer price competition, especially in the electric vehicle (EV) segment. This trend is particularly noticeable at Volkswagen AG, Germany’s biggest auto maker, which has carried out a widespread performance program to restore cost competitiveness.

      An aggravating factor for more indebted SMEs is that the long period of low interest rates and the government support for business during the pandemic had allowed them to continue trading without taking drastic action to address the commercial and finance challenges they faced.

      Conditions have changed for the worse in the past 18 months as government support has ended, lending requirements have become stricter and financing costs have soared. Expectations that central banks will loosen monetary policy only gradually as inflation starts to subside suggests relief from high interest rates may be slow in coming.

      Limited scale, narrow focus, weak pricing are common weaknesses at troubled companies

      If we look more closely at the German suppliers in financial trouble, several other themes emerge which are particular to the companies, often controlled by families or private equity:

      • Lack of scale: most of the firms had yearly revenue of less than EUR 100m.
      • Narrow focus: small ranges of low-margin products such as sheet-metal and injection-moulded parts, aluminium castings, accessories. With limited limited/concentrated product portfolios. they are more vulnerable to the loss of major orders/clients or to shift in demand for such specific products.
      • Weak pricing power: inability to pass on cost inflation to customers through price increases (despite some escalation clauses).

      Against this background, further insolvencies of smaller suppliers with limited international exposure and weak balance sheets are to be expected.

      Deeper-pocketed, diversified suppliers remain resilient…

      However, we do not anticipate a dramatic collapse of the German automotive supplier industry in 2024. Larger suppliers such as Continental AG, Hella KGaA, SAF-Holland SE and Vitesco AG are better positioned to cope with the industry downturn.

      One reason to think so is the relatively encouraging recent financial performance and guidance from larger equipment makers elsewhere in Europe such as France’s Forvia SE, Valeo SE and OPmobility SA (formerly Plastic Omnium). These diversified suppliers are forecasting a slowdown to single-digit percentage growth in revenue this year after double-digit increases in 2023 but expect to maintain, if not improve, operating profit margins by cutting costs, managing inventory more tightly, sometimes reducing headcount significantly. Those exposed to the weaker commercial vehicle markets such as SAF Holland will be under greater pressure but still look resilient.

      … And better placed for new opportunities in structural transformation of sector

      This short-term outlook should be analysed in conjunction with the mid-term strategies implemented by large suppliers to adapt to the profound transformation of the global automotive industry, notably the shift away from internal combustion engine (ICE) to electric powertrains, even if the pace of EV adoption has recently slowed down.

      The suppliers’ response entails reshaping business models and product portfolios, divesting non-core activities, streamlining manufacturing capacities, reskilling and reducing their workforce. Large firms announcing significant job cuts include Robert Bosch GmbH (3,200 jobs in the auto unit), Continental (7,000 jobs or around 7% of its auto unit workforce), ZF Friedrichshafen AG (12,000 jobs or 22% of its domestic headcount by 2030), Forvia (10,000 jobs by 2028 or 13% of its European workforce), Webasto SE (around 2%) and Valeo (around 1% of worldwide staff).

      Opportunities may arise for those suppliers exposed to promising business lines, ranging from battery-pack housing to advanced electric/electronic components, and/or capable of adjusting their portfolio mix accordingly. Conversely, suppliers which are slow or unable to diversify away from ICE-related products and invest more in electrification and software will face a sustained squeeze on cash flow.

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