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By Tom Tharayil
We believe the ongoing crisis will temporarily disrupt the automobile supply chain but have a limited impact on long-term production.
The conflict between Russia and Ukraine has created extensive challenges for the auto industry’s supply chain, which had yet to normalize post-COVID. Although Russia and Ukraine together only represent 2.1% of global light vehicle sales, the impact for some European original equipment manufacturers has been disproportionately larger than for others. For example, 22% of Renault’s global unit sales, or 15% of its operating income, comes from AvtoVAZ in Russia while most other European OEMs have 1-2% of sales in Russia/Ukraine and proportionate operating income.
Larger risks to the sector arise from 1) the supply of palladium used in catalytic converters for internal combustion engines (with Russia accounting for 40% of the global market for mined palladium) 2) the supply of neon gas used for lasers to manufacture automotive semiconductor chips (with Ukraine accounting for 70% of the world’s output) and 3) the supply of wire harnesses for automobiles (with Ukraine exporting 7% of the wire harnesses going to the European Union. Additionally, specific German and Italian OEMs and parts suppliers use natural gas from Russia (40% of the EU’s natural gas supply) in casting, paint curing, heat treatment, and more.
Chip manufacturers have built up several months of neon gas inventory, while OEM factories in Eastern Europe are sourcing alternative suppliers for palladium outside of Russia. Surprisingly, many of the wire harness factories in Ukraine continue to operate at between 30% and 70% of capacity as the conflict has not yet affected supply routes. Separately, with pipelines already in place, countries including Italy have arranged to increase their supply of natural gas from Algeria and reduce dependence on Russia.
We believe the ongoing crisis will temporarily disrupt the supply chain but have a limited impact on long-term production.
Supporting our view are passthrough mechanisms with a time lag of three to six months and 50-70% cost recovery to OEMs. Many OEMs are already reporting increased production on the back of the abating chip shortage. At the same time, low inventories, higher selling prices, and a large demand backlog form the basis of strong sector tailwinds, despite the impacts of high inflation on some of that backlog. We remain positive on the sector, anticipating a recovery in the second half of 2022, assuming a near-term resolution to the conflict. However, a prolonged war could hamper the recovery well into 2023, particularly affecting European OEMs, although the rest of the world would be relatively insulated.
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