(Bloomberg) -- A mild rally in the shares of automakers after the European Union voted to impose tariffs on electric vehicles from China does little to alleviate a bleak year for the sector’s investors.
With the industry reeling from a series of profit warnings, threats of factory closures and growing concerns over balance sheets, the bloc’s decision wasn’t exactly a positive. Many European carmakers opposed it, seeking to avoid a trade war with a key market just as they are grappling with an uneasy investor base.
Short sellers are increasingly targeting Europe’s worst-performing sector this year, analysts are slashing stock forecasts and credit investors are cutting exposure. The cost of insuring the debt of some top carmakers against default has climbed to the highest in at least a year.
“We have seen a series of profit warnings, and we think it’s not over,” said Alexis Foret, a bond portfolio manager at Edmond de Rothschild Asset Management. “These are large companies with a good liquidity position, but they are also credits that are deteriorating. We have to be cautious.”
Carmakers from Mercedes-Benz Group AG to Aston Martin Lagonda Global Holdings Plc have issued profit warnings in recent months, while Stellantis NV is expecting its free cash flow to plummet into negative territory. Volkswagen AG has caused consternation in Germany by considering shuttering factories there for the first time.
Investors have responded by heading for the door. While the Stoxx 600 autos and parts index rose on Friday, that’s because the news was already priced in, said Tom Narayan, an analyst at RBC Europe. The index is down about 11% this year — with carmakers in the region losing around €60 billion ($66 billion) in value — and that’s with the ever-ascending Ferrari NV in the mix.
In the credit market, an index of automotive bonds is at its widest spread over a broader corporate index in four years, an indication of how much more expensive they have become relative to debt from other blue-chip firms.
“The performance of the auto sector in the coming weeks and months will be capped by deteriorating fundamentals into 2025, irrespective of the ‘value’ argument,” UBS Group AG analysts including Patrick Hummel wrote in a recent research note.
The value argument is that autos are the cheapest sector in Europe, trading at 6 times forward earnings on average — an almost 60% discount to the Stoxx 600. Businesses are now priced at an almost 40% discount to their forward book value, a sign of eroded confidence.
“As long as the automotive margins continue to decline with no foreseeable end, the auto stocks are neither cheap nor attractive,” said Moritz Kronenberger, a portfolio manager at Union Investment.
That’s leading to an increase in bets on further declines. The weighted average of shares out on loan on the auto index, an indication of short selling, represents 5.1% of the sector’s free float, according to data from S&P Global Market Intelligence. That compares with about 2% at the start of the year.
Bank analysts appear overly positive on the sector, given many still retain buy ratings and high price targets. As brokers start to integrate profit warnings into their models and raise concerns around debt, more downgrades may follow those seen in recent weeks for Stellantis, Mercedes and Aston Martin.
Oddo’s Michael Foundoukidis and Anthony Dick see Aston Martin’s profit warning as raising concerns around liquidity that were particularly striking due to the carmaker’s high leverage. They also downgraded Stellantis, citing worries around credibility, visibility and the outlook for shareholder returns.
“This is a critical and dramatic change in the industry. Next, investors will look at which companies have the most cash on their balance sheets and can endure the downturn the longest,” said Kronenberger, adding company dividends and share buybacks could be at risk.
Companies have been forking out to invest in electric vehicles, yet sales are enduring a slump. Now, they face the risk of Beijing putting its own tariffs on European cars in the world’s biggest automotive market.
“The imposition of EU tariffs on Chinese EVs will complicate an already difficult picture even more for European car manufacturers,” said Nesche Yazgan, a credit analyst at RBC BlueBay Asset Management. “Newton’s Third Law of motion comes to mind when it comes to tariffs: there is an equal and counter reaction to every action.”
The growing financial questions are being reflected in the cost of insuring their debt. Volkswagen’s five-year credit default swaps hit the highest in nearly a year earlier this week, while Stellantis and Renault have also seen their CDS prices rise sharply in recent weeks, even as broader CDS indexes are steady.
“Generally these companies are IG-rated and have solid balance sheets. But the reality is, they are capable of burning cash in a very short time — they can burn billions in a quarter,” said Yazgan.
--With assistance from Michael Msika, Bruce Douglas and Lisa Pham.
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