Great Inflation Surge Fuels New Hotbed of Distress in Europe

(Bloomberg) -- It has been, by almost any measure, an extraordinary few years for the likes of Mercedes-Benz Group AG and Renault SA: Soaring vehicles prices have fueled record profit margins.

Most Read from Bloomberg

US, Europe Growing Alarmed by China’s Rush Into Legacy Chips

Charles Koch-Tied Group Seeks to Block Trump From GOP Nomination

Stock Rally Takes a Break as Treasury Yields Climb: Markets Wrap

Asia’s Richest Families Fuel Race for Lucrative Finance Jobs

Singapore PM to Address Political Scandals in Parliament

But for the companies that make everything from the wiring to the sealing systems and thermal insulation that go into their cars — and virtually every other vehicle made in Europe — it’s been nothing short of a disaster.

From supply-chain disruptions and labor strife to rising material and energy prices, the cost of doing business for firms such as Standard Profil Automotive GmbH and Adler Pelzer Holding GmbH has skyrocketed. At the same time, the industry’s penchant for long-term, fixed-price contracts has prevented many parts suppliers from passing on those costs to their big-name customers.

Their struggles offer a window into one of the cruel realities of the great inflation surge that’s reshaped the global business landscape: while some companies have been able to capitalize on rising prices to supercharge earnings, others have had little choice but to bear the brunt of higher costs themselves, often accumulating mountains of debt in the process.

“It’s a daily fire drill for supplier executives,” said Michael Robinet, an executive director at S&P Global Mobility. “If there were only one or two issues at a time, they would be manageable, but between the pandemic, inflation, labor issues and the constant pressure to invest in new technologies, everything just happened all together. On top of that, the biggest problem that continues to loom is that their debt will soon come due and it’s going to be much harder and more expensive to refinance.”

The auto industry has been one of the surprise winners of the pandemic-era economy. Tight inventory brought on by factory and supply-chain disruptions allowed manufacturers and dealers to significantly increase prices, more than offsetting slower sales.

But erratic production volumes proved devastating to parts suppliers. Many faced abrupt order cancellations. Negotiating power swung dramatically in favor of automakers, which were able to use the threat of moving their business elsewhere to extract favorable deal terms.

Meanwhile, input costs for suppliers began surging. Prices for materials like petrochemical-based resins and hot-rolled steel jumped, while the Russia-Ukraine war pushed energy costs higher.

Contract Pain

It proved particularly painful given many parts suppliers were locked into multiyear, fixed-price contracts with automakers, a standard practice in the industry.

German sealing-system provider Standard Profil spent months seeking to renegotiate deals with customers, according to recent corporate filings. The private equity-owned company sells its products to roughly 90 plants across the world, which produce cars for the likes of BMW AG and Renault. Amid slow progress, its cash pile dwindled, and its bonds plunged to as low as 56 cents on the euro.

Eventually owner Actera Group injected €10 million ($11 million) to bolster the company’s finances, and in May the supplier announced it would receive €15.2 million from customers to compensate for higher costs. While its bonds have partially recovered, they’re still trading well over 1,000 basis points relative to their benchmark, a level typically associated with distress.

“Parts suppliers need to pass through their higher costs to automakers, but sometimes adjustments are not built into their contracts and they have to renegotiate them,” said Matthias Heck, a senior credit officer at Moody’s Investors Service. “Even if they manage to adjust them, there is a lag.”

A representative for Standard Profil didn’t respond to a request for comment.

Some firms have already sought to get ahead of their maturities.

Adler Pelzer, which makes acoustic and thermal components, earlier this year wanted to get creditors on board with a plan to refinance €425 million of bonds due in April 2024. The company ultimately offered a yield of 12%, and shareholders provided a €120 million cash injection, to get the deal across the finish line.

“With the maturity wall peaking in 2025 and 2026, the next few years will be a big test” for auto-parts suppliers, said Hayley Tipping, a London-based analyst at asset manager Columbia Threadneedle. “It’s not as straightforward as saying all of these companies will go bankrupt. But definitely some companies have a lot of work to do between now and their maturities to make sure that they can afford higher costs of capital.”

A spokesperson for Adler Pelzer didn’t respond to a request for comment.

Despite the difficult business environment, there are signs that the worst may be over for parts makers. Production volumes for vehicles are picking up, shortages of key components such as semiconductors are abating, and raw materials costs are stabilizing.

Bonds of Grupo Antolin-Irausa SA, which produces components for car interiors, were last quoted around 850 basis points over their benchmark, compared to almost 1,000 in May.

Schaeffler AG, which makes parts for engine, transmission and chassis systems, earlier this year had its credit rating boosted to investment grade by Moody’s, which said it expected margins to strengthen over the coming years amid a recovery in vehicle sales.

Representatives for Grupo Antolin-Irausa and Schaeffler didn’t respond to requests for comment.

Read More: Stellantis Targets Suppliers to Cut Costs, Protect Profit

Still, many industry watchers say parts suppliers face a tough road ahead.

Stellantis NV Chief Executive Officer Carlos Tavares said last week that the maker of Jeep SUVs is looking for better deals on components in an effort to protect its margins.

And the European Union is seeking to accelerate the region’s transition to electric vehicles, a shift that will require significant investment from component makers.

“It’s a really decisive time for auto-parts makers” said Dominik Foucar, a Munich-based partner at Bain & Co. “Companies must cut costs and redesign their portfolio with less expensive products to make, while at the same time preparing for the future.”

--With assistance from Craig Trudell and Albertina Torsoli.