High Yield : Auto parts industry: Getting electrified

After a sharp decline of auto production in 2020, the car industry was expected to experience a strong rebound in 2021. However, supply chain and chip shortage headwinds across the globe cut the recovery to 73mn light cars produced or just +4% vs. 2020 level. Although the supply of chips has almost normalized (3.5mn cars were not produced in Q3 FY2021 vs. 0.5mn in May-April 2022) , supply chain issues primarily related to zero covid policy in China are still in place . Also, the supply-side of the industry got new challenges YTD , such as a war in Ukraine (disrupted supply of wiring harnesses in Europe) and rising prices of raw materials. So far, OEMs have been able to pass on cost increases to customers and maintain (or even boost) margins – about +20% price increases vs. 2021. Despite that, the pent-up demand is estimated at 7mn cars. In our view, the production of cars will strongly recover towards the end of the year. However, the demand side of the equation is getting rather uncertain – inflation, rising gas prices and interest rates have significantly hit consumer sentiment. As major central banks are reiterating their stan ce on fighting inflation via tighter financial conditions, we believe that this will eventually result in a massive decline of the aggregate demand early 2023 that bring s uncertainty whether a consumer will be there when the supply-side normalizes and what will happen to elevated OEM’s margins . Auto suppliers have been able to pass about 80% of cost increases so far => hit on margin. Another topic of this pape r is EV transition. In the last year study Transition to EV will be smooth in €HY , we concluded that electrification is a major transformation for the industry in its 100-years history and today we reiterate our view. 2021 saw the continuation of the exponential trend – the EV production was +108% last year. Continuing technological improvements and new battery types will result in further decline of battery prices (albeit slower due to increasing commodity prices) that will support the industry transition to EV from ICE. Also, life cost of ownership is already $6,000 to $10,000 lower for EV over ICE. With that , we continue to focus on how auto parts suppliers are adjusting to the industry transition – diversifying away from ICE exposure is key. Finally, we initiate coverage of Gestamp and Antolin. In terms of RV , although we believe that the industry will experience a strong rebound in H2 this year, it will be constrained by the ongoing negative macro environment in the short-term. Therefore, we reiterate our recommend ation to underweight exposure to auto parts. With that, we think that Valeo, Faurecia and Gestamp are fundamentally strong names and will navigate well in the current environment . Antolin, on the other hand, has relatively high exposure to Europe, low margin , negative FCF generation and elevated adjusted leverage – will continue to underperform , in our view, as the management has limited options to improve the situation.