Asian companies have invested heavily to gain global dominance in electric vehicle (EV) supply chains. To keep their lead, many EV battery suppliers are increasingly investing abroad. Leading players with strong global partnerships will stay on top amid this industry shift. Some weaker ones in China may not survive.

China's battery industry is the most vulnerable to consolidation over the next few years, due to overcapacity. By our estimates, utilization at battery factories in China languished at under 50% over the first eight months of 2023. Exports are helping to offset some of the pain, with China's share of the global battery market on the rise.

We believe battery makers with stronger export channels and global alliances will outperform in the coming years. Chinese suppliers will focus on increasing their market share in Europe. Korean and Japanese competitors see stronger opportunities in North America, where they face less Chinese competition due to U.S.-China trade tensions.

More Signs Of Oversupply For China EV Battery Markets

China's outsized battery-making industry could see a meaningful consolidation over the next three to five years. Suppliers with less-competitive products could struggle to stay afloat if demand does not improve.

Inventory is building for battery suppliers and automakers. One stark sign of this: the battery installation-to-production ratio dropped to 48% in the first eight months of the year, compared with 76% in 2020 (see chart 1). Some producers are particularly hard hit (see chart 2). We attribute this to weaker technology offerings and intensifying competition as market growth slows. Leading players in China are gaining share (see chart 3).

Chart 1

Chart 2

Chart 3

China's crowded market has weakened pricing power in the industry. This has even weighed on margins of those seeing good volume growth (see chart 4a and 4b)

Chart 4a

Chart 4b

The Boost From Rising Exports Is Not Equal

Demand needs in overseas markets will help Chinese battery players that have penetrated into global auto supply chains. Given battery-supply chains are less developed outside of Asia, many global automakers need to import batteries as they accelerate electrification.

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While it will take another few years before their planned local supply facilities become functional, we see scope for China's EV batteries to gain further momentum over the next two to three years. Especially promising is Europe, where the Chinese players have been gaining share from Korean competitors through increasing battery exports from China (see chart 8).

In our view, political risk is relatively lower for Chinese players to penetrate into the market in Europe versus the U.S. The European Commission's recent investigation into government subsidies on EVs from China should not have direct impact on battery players' expansion. At the end of the day, European automakers are in need of battery supply and local companies don't yet have sufficient capacity to support the local EV market growth .

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Chart 8

At the same time (see table 1), some major Chinese players are also establishing production facilities in Europe. This, in our view, will enhance their market access in the region. It's also a strategic response to more clarity on potential regulatory changes in Europe with regard to self-sufficiency of strategic raw materials.

Table 1

The proposed Critical Raw Materials Act (CRMA), introduced by the European Commission on March 16, 2023, aims to foster the development of local supply chains for 34 critical raw materials, such as cobalt, manganese, and lithium (battery grade) by 2030. The European Union also introduced battery-related environmental regulation, including a recycling requirement, in July 2023.

Table 2

Table 3

While these ground rules could be further refined, they provide enough certainty to attract further expansion by some China-based competitors. We anticipate stronger players will hasten plans to localize their battery supply chains and enhance their recycling capabilities. That said, some Chinese battery makers may find it difficult to meet the necessary requirements (see tables 2 and 3) to penetrate into the region. Higher research and development costs for material recycling, as required by Europe, could also weigh on their profitability over the next few years.

Korean Players Look Set To Dominate North America's Battery Market

We anticipate Korean players, which used to dominate in the European market, will prioritize the U.S over the next two to three years. A key lure is tax incentive under the U.S. Inflation Reduction Act (IRA) of 2022. This legislation seeks to establish an onshore EV value chain.

By localizing their production of clean-energy components within the U.S., Korean players are eligible for the Advanced Manufacturing Product Credit (AMPC) under the IRA (see table 4). Korean suppliers set to overtake Panasonic Holdings Corp. as the leading player in North America (see chart 9). Although Panasonic is also expanding its capacity in the region, its pace is relatively more conservative than that of the Korean competitors.

Table 4

Chart 9

Meanwhile, the majority of Chinese players will likely refrain from meaningful direct investments due to intensifying geopolitical tension between China and the U.S. Indeed, under current terms of the IRA, an electric car would be ineligible for tax credits if its battery components are manufactured by Chinese producers from 2024. Without the same entitlements, Chinese players would lose cost competitiveness.

Some "First Movers" Are Still Reaping Rewards

Some first movers like China's Contemporary Amperex Technology Co. Ltd. (CATL) and Korea's LG Energy Solution Ltd. (LG Ensol) have been strategically expanding capacity in the global battery industry since prior years. This first-mover advantage should support them to firmly stay in top-three of global battery supply despite rising competition on more global entrants (see chart 10). By our estimates, their revenue will grow by double-digit percentages annually through to 2025.

Chart 10

Table 5

CATL and LG Ensol's profitability is set to improve in 2023 and 2024

Some battery makers will also benefit from moderating input costs such as lithium, cobalt, and nickel--down 20%-60% in the first eight months of 2023. Raw-materials contribute at least 70%-80% of the total cost of EV batteries. This trend, together with improving economies of scale, should mitigate against pricing pressure for CATL; its EBITDA margin should improve a bit in 2023-2024 despite intensifying battery competition in China.

LG Ensol's margins will keep getting stronger over the next few years. In the U.S., the company should receive production credits of US$1.5 billion-US$2.0 billion over 2023 and 2024. Coupled with increasing electrification boosting battery demand in the U.S. and Europe, the company's EBITDA margin will likely rise to 17%-22% over this year and the next, from 12% in 2022.

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First-Mover Risks Will Pay Off…Only For The Winners

Asia's top battery players have taken a lot of risks to be global leaders in the EV supply chain. They've built up capacity for a market that has not yet fully arrived. To keep their lead, they now need to shift more investments abroad, even with oversupply in some home markets.

In our view, the benefits outweigh the risks for leading players. For most rated players (see next section for individual-company outlooks), profits and cashflows will be strong enough to finance higher investment costs. Other players will offset higher spending abroad with more cautious capital expenditure (capex) in domestic locations. Most of the rated EV battery makers are stronger players, who can hold their own as this industry evolves to the next stage.

Rated Asian Battery Markets: Capsule Analyses

Contemporary Amperex Technology Co. Ltd. (CATL; BBB+/Positive/--): Can maintain net cash as it accelerates international growth.  CATL will grow its international business by leveraging on its abundant production capacity in China and strategic relationships with international automakers. CATL's ability to meet new battery-related regulations in Europe, such as on recycling raw materials, will give it an edge in that large market. CATL is the leading battery recycling player in China and will continue to expand its supply chain through cooperating with local players in Europe.

The company's EV battery installations outside of China increased 107% year on year in the first half of 2023 and more capacity is coming (see table 1). Its market share in non-China markets also reached 27.2% during this period, up from 20.5% in 2022, according to consultancy SNE Research.

CATL will likely remain in a net cash position over 2023-2024, and likely longer. Profit expansion and cautious domestic capex should support higher free cash flows.

LG Energy Solution Ltd. (LG Ensol; BBB+/Stable/--): Earnings growth to mitigate rising capex.   Korea's LG Ensol is strategically partnering with automakers to localize battery production in the U.S. and receive tax credits in the process. A number of joint ventures have been and will be established and billions of dollars will be spent on battery capacity expansion in the U.S. over the next few years.

Table 6

We estimate LG Ensol's capex burden will expand significantly over 2023-2025, and this will lead to negative discretionary cash flows over the next two to three years. As a result, its adjusted debt could rise to Korean won (KRW) 19.4 trillion (US$14.6 billion) by 2025 from KRW2.8 trillion (US$2.1 billion) in 2022.

We believe, however, the company's debt-to-EBITDA ratio will likely remain below 2.0x through its high investment cycle, ranging between 1.5x and 2.0x in 2023-2025 from 0.9x in 2022. Its capex should peak in 2024 as majority of the investments will be made over 2023-2024.

In addition, the company's strong EBITDA growth, driven by economies of scale, higher bargaining power, and production credits in the U.S., should help LG Ensol keep its leverage steady over the next two to three years.

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SK Innovation Co. Ltd. (SKI; BBB-/Negative/--): Aggressive expansion tightens rating headroom.  We expect SKI, the largest oil refining company in Korea, will continue to invest aggressively in expanding EV battery capacity as its new growth business. Through its subsidiary SK On Co. Ltd., SKI is the fifth largest battery manufacturer globally, based on market share in the first seven months of 2023.

SK On operates its own EV battery plants in the U.S. state of Georgia (22 gigawatt hour [GWh]) in 2022), and targets to add more capacity via its joint venture with Ford (129GWh in total) and with Hyundai Motor Group (35GWh).

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With significant investments in EV battery capacity, and its battery business still in the loss-making state, SKI's leverage will likely remain elevated over 2023-2024. As such, the ratings headroom is thinner than some other EV battery makers.

We expect SKI to gradually reduce leverage, through improving profitability of the EV battery segment and U.S. tax-credit benefits over 2024-2025. At the same time, downside risks could arise from incremental investments beyond our expectations and potential execution and competition risks. Of note, the company is working on various nondebt financing efforts, including its recent equity issuance of KRW1.1 trillion in September 2023.

Panasonic Holdings Corp. (A-/Stable/A-2): Leverage to keep steady on cautious expansion.   Out of its five business segments, Panasonic now places a higher focus on its EV battery business in U.S. This is given a high growth potential amid the electrification of the auto industry. Panasonic is leading appliance and electronics manufacturers in Japan and the number-three global EV battery supplier (in the first eight months of 2023).

The company's capex will rise on its battery capacity build-up over the next few years. Due to the U.S. tax incentives for onshore facilities, Panasonic is now building its second battery plant in Kansas after its first in Nevada for assembling 2170 batteries for Tesla in the U.S. We estimate Panasonic's capex will advance to US$4.8 billion annually in 2023 and 2024 from US$2.3 billion in 2022.

Nonetheless, the company's expansion appetite is still relatively lower than that of the Korean players. We also expect Panasonic's battery businesses to keep growing and with improving profitability under the AMPC benefit. This together with an expanding customer base (e.g. Mazda) for its batteries should largely mitigate its capex increase. We forecast debt-to-EBITDA ratio will remain low at 1.0x-1.3x in 2023 and 2024.

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