Supply Chain Pressures Persist

Global nonfinancial corporates appear to be taking supply chain disruptions and soaring cost inflation in their stride. S&P Global Ratings’ analysis suggests that in 54 out of 78 global sectors, most companies are finding it very easy or somewhat easy to pass on costs. Based on the last 12 months' results, EBITDA margins look set to hit a new high in 2021.

Cost increases have been absorbed or negated in a variety of ways – demand offsets, demand shifts, product mix adjustments, hedging, indexation, positive operational gearing, cost pass-throughs, and keeping pay growth low. In S&P Global Ratings’ view, profit margin pressure will start to ratchet up in 2022. S&P Global Ratings’ analysts expect supply disruption will persist until the end of 2022 for more than half of all sectors.

Pay barely above 2019 levels is unlikely to be sustainable amid strong growth and rising costs, and signs of upward pay pressure are particularly apparent in North America.

While the global hard-stop triggered by COVID-19 and its associated restrictions proved a difficult operating environment for the corporate sector, the global restart has not been without its challenges. Clearly the direction of travel has been positive, with vaccines easing health risks and a barrage of fiscal and monetary policy helping companies avoid drastic labor cuts, providing supportive financing conditions and boosting revenues.

Nonetheless, the sheer scale of pandemic-related disruption and altered consumption patterns, along with existing political pressures on supply chains, have created considerable difficulties. Input and freight costs have risen dramatically, shipping volumes have surged and created bottlenecks, and lead times for manufactured goods have worsened.



Input Costs Have Soared Above Pre-Pandemic Levels

The magnitude of input cost inflation in the past couple of years is extraordinary and has taken the prices of a swathe of key production inputs far beyond their pre-pandemic levels.

S&P Global Ratings research shows the percentage changes in prices for a global basket of input costs, encompassing agricultural goods, energy, forest products, metals and precious metals, and key technology items. Of the 52 items shown, prices for only two fell (wool and cocoa), and for another two (palladium – used in catalytic converters – and coffee) rose less than 10%. The average increase versus pre-pandemic levels has been 95% and the median 52%. Even if rates of increase slow, these are substantial level changes in input costs.

Equally large rises in the freight costs of moving these items also add to the greater input-cost burden.

S&P Global Ratings is revising downward their expectations for global light vehicles sales in 2021 and 2022 in light of the intensifying shortage of semiconductors, which resulted in material unit losses during the third quarter. Visibility remains low because the supply-demand imbalance of chips continues to be amplified by some further negative events, such as the production shutdowns and resurgence of COVID-19 in Malaysia. Because the chip shortage has spread to consumer electronics, S&P Global Ratings assumes that auto production will continue to be constrained into 2022 before gradually returning to normal in the second half of next year.

In S&P Global Ratings’ revised scenario they now expect light vehicles sales will increase moderately by about 2%-4% this year (versus our previous projections of 8% to 10%). This translates to sales just below 80 million units in 2021 compared to 83-85 million units in our previous projection in May this year. Based on the limited visibility on semiconductor supply since the crisis first emerged, S&P Global Ratings expects the shortage will extend into 2022. This has led S&P Global Ratings also to revise downward their projection of light vehicle sales for 2022 to 84 million units (from 87 million in our projection earlier this year). S&P Global Ratings nevertheless assumes supply constraints will ease gradually, leading to a recovery of light vehicle sales to 90 million by the end of 2023. This is because macroeconomic conditions remain fairly supportive globally, notwithstanding a flatter-than-expected recovery from the COVID-19 shock.

S&P Global Ratings doesn't believe the supply-chain crisis on its own will affect auto manufacturer ratings. Despite the persisting lack of visibility combined with the sizable unit losses to production year-to-date, S&P Global Ratings still considers the semiconductor crisis as a temporary supply shock at this stage, exacerbated by other negative events this year that have also led to unexpected production downtime. However, a more prolonged crisis, with major production shortfalls exceeding S&P Global Ratings' 2022 horizon, could lead to more profound revisions to our forecasts of issuers' earnings and cash flows, which could increasingly affect ratings. In S&P Global Ratings' view, the crisis highlights the critical importance of supply-chain management for original equipment manufacturers (OEMs) and has exposed areas of vulnerability. Microchip bottlenecks are all the more acute because of the increasing tech content of more digitized and connected vehicles coming onto the market. This is leading to an increasing number of partnerships in this area (such as VW-Infineon, Hyundai-Magnachip, GM/Qualcomm, Renault-Qualcomm, Mercedes-Nvidia, Toyota-Panasonic, and Stellantis-Foxconn) not just to secure future supply, but increasingly also to gain greater control over the design and development of semiconductors. S&P Global Ratings doesn't, however, expect OEMs to produce in-house.

As many countries shift towards achieving a more sustainable future, major economies are also adopting and promoting electric vehicles in an effort to reduce carbon emissions from traditional internal-combustion engine, and ultimately help the transport and power sectors contribute towards reaching the 2-degree C Paris Agreement goal.

One of the key commodities to realizing this ambition is nickel. Unlike other battery materials such as cobalt and lithium, nickel is unique in not being primarily driven by global battery demand. About 70% of the world's nickel production is consumed by the stainless steel sector, while batteries take up a modest 5%.

S&P Global Market Intelligence forecasts global primary nickel consumption to rebound year-on-year due to stainless steel capacity expansions in China and Indonesia. Demand outside China is expected to be the main driver of global growth in volume terms in 2022 and global consumption is forecasted to rise at a compound annual growth rate of about 7% between 2020 and 2025.

The battery sector's nickel demand is also expected to accelerate substantially, with many predicting it to near 35% of total demand by the end of the decade.

But while based on the above supply of nickel seems abundant, the production of nickel-rich cathodes in lithium-ion batteries requires a more stringent, high-purity Class I nickel (i.e. greater than 99.8% purity) as feedstock to produce the key ingredient: nickel sulfate. Traditional stainless-steel feed of nickel pig iron (NPI) and laterite ores have not been suitable for the production of such batteries.

U.S. supply chain woes will worsen in the near term before easing up well into 2022 as bare shelves persist bare and prices rise.

Transportation is the biggest supply-side problem facing businesses as ships wait to unload off the California coast, said Oren Klachkin, lead U.S. economist with forecasting and analytics group Oxford Economics. Warehousing is also backed up, said Joel Naroff, president of consulting firm Naroff Economics. Bottlenecks in both areas must be fixed before there is a significant reduction in supply chain issues, Naroff said.

"With luck, in six months we should have visible progress, but it could take 12 months before major progress or resolution becomes clear," Naroff said in an interview.

Supply chains are still feeling the effects of the pandemic, which forced businesses to shut down or shift production as consumer needs changed. Consumers have had a difficult time finding certain goods throughout the pandemic as products ranging from appliances to cars to lumber and building materials have been out of stock and backordered. Future shortages may include healthcare products and domestic food production, economists said.

Labor has also been in short supply, complicating the recovery picture. The number of job openings in the transportation, warehousing and utilities industry steadily increased throughout 2021, until there was a slight drop in October, according to U.S. Bureau of Labor Statistics data.



Next shortage

Consumer goods are especially hard hit since the U.S. is reliant on overseas production. Companies that use just-in-time inventory with limited suppliers were not prepared for the bottlenecks the pandemic created.

It is difficult to pinpoint where the next shortage will be since almost every sector is experiencing supply chain issues, Klachkin said. A shortage of healthcare and cleaning goods may re-emerge with the news of the omicron variant, although more information about the variant's spread and health impact is needed, he said.

Amazon.com Inc. and other U.S. e-commerce retailers are likely to pursue deals in 2022 that will further bolster their digital and technology capabilities, a move experts say will help them tighten their grasp on higher levels of online sales in the new year.

Amazon, Walmart Inc., and Target Corp. have emerged as beneficiaries of the pandemic, thanks largely to investments they have made in areas such as delivery, fulfillment, and curbside pickup operations.

The investments they make in 2022 will help them further capitalize on online sales as well as drive demand and efficiencies in areas such as content, delivery, and supply chain, said Tim Campbell, director of industry insights at e-commerce management platform CommerceIQ.

"With e-commerce, they have the reach, and now it's about making it better," Campbell said. "I think that's going to be the trend of 2022."

One of the biggest deals that could advance next year is Amazon's planned $10.56 billion acquisition of film and television company MGM Holdings Inc. It would mark the company's second-largest acquisition behind Amazon's 2017 purchase of Whole Foods Market Inc. for $14.62 billion.



An Amazon spokesperson told S&P Global Market Intelligence that completion of the MGM deal announced in May is "subject to regulatory approvals and other customary closing conditions, and we're working with regulators to respond to requests."

The Federal Trade Commission is investigating the deal but declined to comment for this story.

If approved, the deal would arm Amazon with a content library that includes more than 17,000 TV shows and 4,000 film titles, including the popular James Bond and Rocky franchises. The deal would also give Amazon more exclusive content to further lock consumers into Prime subscriptions, said Wade Holden, senior research analyst with Kagan, a media research group within S&P Global Market Intelligence. "They will be able to say 'if you want to stream all these thousands of titles, they are here on Prime if you want to subscribe,'" said Holden, who focuses on the motion picture industry.

However, the deal faces opposition from several activist groups that have pleaded with the FTC to block the transaction, saying the acquisition is anticompetitive and would enable Amazon to further leverage its dominance in streaming over competitors including Netflix Inc. and Walt Disney Co.'s Disney+ streaming service.

A major failure in supply chain finance has proven to be just a bump in the road for the nascent sector.