Russian for the Exit? How the Invasion Impacts European Auto MakersRussianfortheExit?HowtheInvasionImpactsEuropeanAutoMakers

In early 2021, carmakers found booming demand for their vehicles could not be matched by chip suppliers, which were already running at capacity fulfilling consumer electronics demand.  Since it takes 12 to 18 months to increase chip capacity, there was no immediate solution, and significant supply constraints set in. Throughout the year, this was compounded by energy stoppages in Texas, a fire in a factory in Japan and, finally, COVID lockdowns in Malaysia. This semiconductor shortage is estimated to have reduced global car production by over 10 million units since the beginning of 2021. 

Semiconductor supply is now slowly recovering, with most manufacturers expecting “normal” supply levels in 2023 and sufficient excess semiconductor capacity to allow some catch up vehicle production in 2024.  However, capacity remains extremely tight and risks remain skewed to the downside.

Untangling the Wire Harness Shortage 

Following the outbreak of war in Ukraine, a further threat to the electronics supply chain arose in the form of wire harnesses. These are assemblies of electrical cables that transmit signals or power around a car. While the wire harness is a fairly humble product, it is essential to the operation of a modern vehicle. 

With over 10 km of wiring in a single car, these harnesses are extremely labour intensive to make and typically are manufactured in low-wage economies geographically close to car plants. For manufacturers with plants in Germany and Central Europe, such as VW, Mercedes, and BMW, Ukraine is a key manufacturer. The total Russian and Ukrainian impact on production to date (most of which is wire harness related) is estimated at 150,000 to 200,000 units.  

More recently, wire harness production has started to improve, with several Western Ukrainian plants operating day shifts and some production shifting to North Africa and Mexico. However, wire harnesses are model-specific, and fully transferring production to a new facility can take up to six months—meaning that an escalation of the conflict could cause a new round of plant stoppages.

Roadblocks Ahead

Platinum and palladium are key components of catalytic converters, which are key to meeting vehicle emissions standards. Russia currently produces 12% of the world’s platinum and 40% of its palladium (Figure 2).

Figure 2

If sanctions restrict Russian supply, production could become increasingly constrained. IHS Markit estimates this could cost up to 8 million units of production over 12-18 months.

Running on Fumes

Much of Eastern and Central Europe is powered by Russian gas, and its reduction or stoppage could lead to substantial production cuts for European manufacturers. In addition to electricity generation, car manufacturing requires gas for several industrial processes, particularly in the paint shop. This means finding alternative sources of electricity would only be a partial solution to gas stoppages. German carmakers are clearly most exposed, but many manufacturers have operations in Eastern Europe and only a minority of plants run with sufficient in-place renewable energy to maintain production.

Steel, Noble Gasses, Nickel, and China

Russia and Ukraine are some of the largest suppliers of raw and semi-finished iron and steel to Europe (27% Russia, 17% Ukraine), with most Ukrainian plants situated in Eastern Ukraine where fighting is fiercest. While much of this steel is not of automotive grade, overall prices have risen significantly, putting further pressure on suppliers and manufacturers. 

Another raw metal at issue is nickel, which is a key component of electric car batteries. Russia mines 11% of the world’s nickel and has significant refining capacity. However, we see this as a lesser risk as most companies contract their nickel supply several years in advance and are likely to have avoided Russian sources.  

Finally, the current lockdown in China presents a major threat to global car production. China is the world’s largest car market and, although production is largely localised, further shutdowns pose a risk both to manufacturer revenues and supply chains more generally. Export delays at Shanghai Port have been increasing, and we expect to see some knock-on effects on the global supply chain in the not-too-distant future.

Implications for the Automotive Industry

While supply chain failures represent a growing risk to the market, automotive manufacturer margins remain at an all-time high. Reduced production volumes have driven huge price increases, which have allowed manufacturer revenues to grow even as car sales have plummeted (Figure 3).

Figure 3 

Automaker free cashflow in 2021 was exceptionally strong, and balance sheets are in an excellent position. Nevertheless, the strong pricing environment cannot last indefinitely, and margins should begin to normalise as volumes recover. More differentiation in supply impacts will also create winners and losers as players with capacity flexibility will take market share from more restricted rivals. Auto parts makers are also impacted as a lower ability to pass on raw material costs to customers than the big car makers, coupled with falling production volumes, has caused significant compression in both margins and cashflow.  

Although the war in Ukraine threatens to exacerbate existing bottlenecks, creating clear downside risks for some auto manufacturers, we believe that the auto sector remains attractive with strong cashflow and improving earnings. While current conditions require careful analysis, we remain overweight the sector in global corporate portfolios in light of strong credit conditions, resilient demand, and record high vehicle prices—though ever mindful of the roadblocks that may lie ahead.