(Bloomberg) -- Investors have priced European carmakers for a gloomy outlook, and the reality is slowly proving to be even worse than expected.
It’s been a tough year for autos and the promising recovery from the Covid pandemic now appears long gone. The Stoxx 600 Autos & Parts Index is the second-worst performing subsector in Europe after mining, plagued by ailing demand for cars, margin pressure and the region’s trade tensions with China.
The gauge has plunged 24% since an April peak, hitting a 10-month low this week, and has a history of dropping further during downturns. Volkswagen AG, the region’s largest auto manufacturer, is now trading at its lowest valuation level on record.
“The sector is not yet at a point to bounce back sustainably, even if a short bounce is always possible,” said Wolf von Rotberg, equity strategist at Bank J Safra Sarasin. “It’s the culmination of a structural shift in the market itself, homegrown issues and the prospect of a cyclical downturn which may further weigh on demand and earnings.”
The industry has been struggling with sluggish demand, particularly in the key Chinese market, while firms are facing heavy competition on electric vehicles from the Asian nation’s producers. A trade spat between China and the European Union, as well as stricter EU emissions limits for 2025 that could lead to billions in fines, are adding to the sector’s woes. Volkswagen is considering closing factories in Germany for the first time.
Von Rotberg sees the three major German carmakers as highly dependent on Chinese demand, with more than a third of BMW AG, Mercedes-Benz Group AG and Volkswagen sales volumes going to China. Excess capacity is depressing margins for the industry and it may take months, if not years, to rebalance, he said.
German high-end manufacturer BMW issued a profit warning on Tuesday, dealing another blow to the industry after peers Volkswagen and Porsche AG had already cut their outlook this year. And things may not be over just yet, with “few hiding places” for carmakers, according to Morgan Stanley analysts including Javier Martinez de Olcoz Cerda.
“We are just at the beginning of a long negative margin cycle and 2025-2026 market expectations are still high,” they wrote in a note on Tuesday after the BMW warning. “Who might be next? Stellantis potentially, given bloated inventory and ambitious full-year 2024 guidance.”
Analysts have been relatively slow to downgrade their calls so far. The sector is showing the most potential upside to average price targets, with 33% gains seen over the next 12 months, confirming its deep value status. Earnings forecasts are on the way down but may fall a lot more if the outlook darkens.
Cheapest Sector
Carmakers are the cheapest sector in Europe, trading at just 5.4 times forward earnings on average. That’s nearly a record 60% discount to the broader Stoxx Europe 600. Confidence in the value of their business has been eroded so much that they now trade at about a 40% discount to their forward book value, the lower end of a 20-year range.
“From a risk/reward perspective, some names look quite attractive,” said Mathieu Racheter, head of equity strategy at Julius Baer Group Ltd., citing Mercedes-Benz and Porsche as the bank’s favorite names, pointing to supply-chain issues being either resolved or on the way there. For Mercedes-Benz, Racheter said the depressed valuation and the over-10% yield, when including buybacks and dividends, offers an opportunity.
“We expect improved results in the fourth quarter of 2024 and in 2025,” he said. “The industry is also facing structural challenges, but the shares are already priced for disaster.”
Certainly, the sector was the least preferred in Europe in Bank of America Corp.’s August fund manager survey. Short sellers have also been circling around Volvo Car AB and Porsche recently.
Further heavy recent selling has shown investors are not yet done reducing exposure and could be sensitive to more bad news, according to Marija Veitmane, senior multi-asset strategist at State Street Global Markets. “Broadly speaking, we do not expect prices to start rebounding until the earnings outlook improves,” she said. “For now, earnings downgrades sharply outpace upgrades — hence further underperformance.”
--With assistance from Lisa Pham.
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