The Covid-19 pandemic and the subsequent global shortage of semiconductors has accelerated disruption in the automotive industry. We have outlined herein some of the key issues facing our automotive supply chain clients, which will ultimately lead to substantial working capital investment across the industry. We therefore detail some of the funding options available to businesses within the sector.

Production volume

The Covid-19 pandemic and semiconductor shortage has caused wide-spread disruption of the extensive, diverse and global supply chains in the automotive sector. This ongoing disruption is evidenced by the dramatic downturn in car production in the UK down 37.6% year on year from July 2021 compared to July 2020 (as published by The Society of Motor Manufacturers and Traders). 

A continued lack of certainty on the long-term resolution to these issues means OEM production schedules remain volatile which, with the removal of the UK Government’s furlough scheme imminent, makes operational and financial planning for suppliers challenging. Suppliers are having to make medium-term decisions in respect of maintaining capacity with little to no certainty of volumes returning in the short-term. If capacity is retained and volumes remain low, this could lead to continued losses within the supply chain, absent of any support from customers.

Margin pressures for suppliers

Alongside volume volatility, suppliers are facing wider margin related pressures including, but not limited to:

• Raw material price inflation: Market conditions have driven up the cost of many raw materials across multiple product lines. Several trends such as steel production curbs in China, unprecedented energy price rises and additional non-traffic costs related to the new UK customs arrangements have all significantly impacted input costs. For example, Shanghai steel futures since the start of the year are up 33%, currently priced above CNY 5,500 a tonne in September. China has been reducing steel production to meet environmental standards, raising concerns about global supply amid production curbs. Another example is UK Gas prices which have almost tripled as wholesale prices have increased 250% since January, with no sign of this trend abating in the short term.
• Shipping cost increases: The cost of shipping goods from Asia to Europe has soared over the last year and even more so in recent months. Buyers have seen up to a 75% increase in shipping costs on a 40ft container since the end of April 2021. Delays with shipments have exacerbated issues for many causing some to increase stock levels locally, leading to warehouse capacity issues but also uncertainty over shipping volumes into 2022. 
• Labour inefficiencies: Volatility in production volumes at the OEM level, plus the varying timings of the global operational emergence from the Covid-19 pandemic has caused several shortages of supplies. This, coupled with various shipping delays (including the blockage of the Suez Canal and HGV driver shortages) has led to a lack of availability of raw material. Suppliers have been unable to properly plan their workforce accordingly and whilst the Government’s furlough scheme has helped in some cases, this remains an ongoing operational and margin challenge for suppliers as furlough schemes taper off. 

Where suppliers have been unable to pass increased costs on or have not proactively taken steps to protect the business, the combination of raw material price inflation, freight cost increases and labour inefficiencies have eroded headroom and eroded cash and working capital. In the future, suppliers may consider alternative sourcing strategies (such as nearshoring) in an attempt to mitigate some of the above risks/challenges.

Supply, demand and the future

Despite the challenges, consumer demand largely remains for new vehicles. The reduction in production output has therefore led to a growth in used car prices and sales alongside new vehicle lead times. Whilst consumer trends will undoubtedly shift to electric vehicles in the future, this remains a medium-term strategic change and there will likely be an inevitable catchup in operational output. This will require a ramp up in the sector and may create a tsunami of working capital investment for suppliers that have already been squeezed. 

Businesses that have suffered margin erosion will need to proactively capture new margins and prices before activity rises to avoid further periods of loss-making production. Whilst the supply and demand dynamic will eventually balance out, this may take several years but leading essentially to a structural change to the way working capital facilities are utilised. We expect to see requests to significantly increase facility sizes, which will impact debt levels, leverage ratios and associated covenants, all of which may need to be reassessed going forward. Lenders, credit insurers and equity providers are acutely aware of the challenges facing the automotive sector and therefore work will also be required to improve appetite going forward which will likely only be driven by a period of stability in the sector. 

What options are available to fund working capital? 

The sector will remain dominated by the large OEMs which will benefit the whole industry given the underlying credit fundamentals. The challenge for the smaller businesses in the supply chain is demonstrating how close and critical they are to the OEMs to ensure they retain access to committed funding lines.    

Where working capital funding becomes squeezed (as described above), there will be increased competition and challenges on securing a share of the reduced level of facilities available from the traditional banks. 

Consideration will therefore need to be given to a wider range of potential funding solutions: asset-based funding for stock and receivables, opportunity funds providing debt/equity combinations; government supported schemes (e.g. Export finance); and supplier finance. We expect to see all of these become increasingly relevant and important alongside a reduction in appetite from the traditional sources of finance. In addition, funders may expect and need to see support from customers and shareholders in order to underpin their risk appetite before confirming their ongoing commitment.  

Alongside headline debt levels, any increase in ancillary funding requirements will place a higher burden and strain on the availability of capital. Bonding lines, guarantees and letters of credit all require bank balance sheets and the increased level of hedging resulting from market volatility will squeeze the ability for banks to provide core funding (as the ancillary facilities become more critical). 

Given the range of dynamics at play, both with regards to sector challenges and specific to the debt financing of the sector, refinancings will prove increasingly challenging with businesses trying to ensure that they don’t lose out because of the funding squeeze.

How A&M can help?

A&M advisors have extensive situational experience working with management teams to deliver proven results.

Our debt advisory professionals can support in managing existing lenders where an unforeseen change in the business has occurred as well as considering alternative debt products and structures that better fit the risk, credit and funding profile of the business.

Our Restructuring team help management teams look forward to assess the impact on the business and what actions the business can take to right size their business to match lower levels activity. We can also help companies to mitigate any increased funding requirement and manage their external stakeholders through challenging times.

A&M’s Automotive sector team helps OEM’s and auto suppliers transform operations, maximise growth and build resilience to the latest challenges faced. When traditional improvement activities are not enough, A&M’s restructuring and turnaround heritage brings fact-based, action-oriented leadership to transformation, delivering rapid cash and P&L benefits.

A&M has a series of risk assessment and mitigation tools available to help businesses with sourcing materials from alternate markets, logistical mitigation as well as teams on the ground in Asia with situation updates.

A&M can assist businesses within the supply chain impacted directly, or the larger corporate seeking to understand and mitigate their broader risks within the supply chain by:

• Assessing options and sourcing access to short term funding solutions;
• Managing and understanding the short-term impacts on liquidity through robust short-term cash flow forecasting;
• Managing and communicating the impact of the above to stakeholders including lenders, customers and suppliers;
• Review and understand the supply chain to estimate the impact and devise strategies to reduce the financial impact;
• Effective working capital management to maximise the cash position throughout the short-term disruption.