Auto supplier debt could drive more bankruptcies, consolidation, Deloitte study finds

Elevated supplier debt levels and inflationary pressures could soon lead to more bankruptcies and accelerate consolidation in the supply base, according to a recent analysis of supplier financials by Deloitte.

Compared with their automaker customers, suppliers have taken the brunt of the financial hit from the production challenges of the past few years. Many parts companies took on more debt in order to stay afloat as material costs rose, and also to pay for new investments in vehicle programs related to electrification and advanced driver assistance systems.

But now that interest rates have climbed and credit is tighter, that has left many suppliers, especially smaller ones, burdened with higher costs. And that is putting even more pressure on the supply base, Deloitte warns.

The risk of supplier bankruptcies "may be increasing over time," Deloitte concluded in its 2023 Automotive Supplier Study, which analyzed financial data from about 300 suppliers.

"With inflation pressure and debt covenants coming due and suppliers having to renegotiate at much higher interest rates, that financial squeeze is going to be harder," said Jason Coffman, Deloitte's head of U.S. automotive consulting. "We've seen a little bit of weakness with a few bankruptcies to kick off this year, even if sales so far has been a little bit stronger than the conservative expectations going into this year."

A handful of suppliers to both automakers and other parts producers have entered bankruptcy or indicated they are on the brink of insolvency over the past several months.

In February, North Carolina-based Stanadyne filed for Chapter 11 bankruptcy, in part because of rising interest rates. Michigan-based supplier Gissing North America filed for Chapter 11 last year.

The growing potential for bankruptcies drives home the segment's precarious financial situation over the last four years, starting with the 2019 UAW strike against General Motors, followed immediately by the early 2020 onset of the COVID-19 pandemic.

The study reports that some larger Tier 1 suppliers, who can generally sustain economic pressures better than their sub-suppliers, have raised concerns about the fragility of their own supply bases in the near-term. Tier 1 suppliers and their customers will need to closely monitor the status of their extended supply chains in the coming months, Coffman said.

"As we've seen with the pressure around microchips, we need to get ahead of that. Volatility is only going to continue," he said.

But even larger suppliers have been under intense financial pressure and are working to reduce debt. For example, Cooper-Standard's debt levels rose to about $1 billion (all figures in USD) at the end of last year, with higher interest rates sending its net interest expenses up by about $6 million.

Some suppliers with substantial debt levels saw their balance books improve a bit last year. American Axle & Manufacturing saw its total debt outstanding decrease to $2.92 billion at the end of 2022 from $3.1 billion a year earlier, according to the supplier's annual report. Interest expense fell to $174.5 million from $195.2 million, though the company expected that figure to rise to as much as $205 million in 2023.

While automakers can easily pass higher costs on to consumers or to their suppliers, parts makers don't have much wiggle room, said Tony Flanagan, a managing partner at consulting firm AlixPartners.

"If you're a supplier, you have a contract with the OEM, and you can't just unilaterally change that," he said. "So now you're getting the higher costs without being able to pass that on to the OEM, short of a protracted negotiation with them.

"Your costs are higher, and your revenues are lower. So your debt levels are going to stay constant or go up," he said.

With cash less available and with significant pressure to invest in emerging mobility fields, many suppliers are asking whether it might be best to divest some of their businesses or open themselves up to an acquisition or merger. According to the Deloitte study, that means that suppliers or private equity firms could find bargain acquisitions now.

"There may be a number of undervalued players that would be attractive targets for either strategic or financial buyers looking to take advantage of current conditions," the study reads. "Indeed, the potential for more M&A activity on the horizon in the supply sector is growing rapidly."

The conditions for increased M&A activity could persist into next year as suppliers scramble to find their place in the new market for EVs, Flanagan said.

"Some suppliers have solid positions, while others are still searching," he said.

The shift to electrification is also putting new financial pressure on some legacy suppliers. The Deloitte study projects that total revenues for electric drivetrains and battery fuel segments will surge 245 per cent from 2022 to 2027, while revenue from components related to internal combustion engines will dip 44 per cent in that time, it forecasts.

But Flanagan believes many suppliers are being proactive in making plans to weather the disruption.

"They're not just sitting there taking this," he said. "There are just certain things that are out of their control in the near term."