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Is the party over for German auto manufacturers?

The essential

After years of outperformance, the German auto industry seems to have peaked in profitability, but results since 2012 have not seen growth. 

Some markets have proven less solid but it is clearly the need for investments that is currently limiting short-term improvement of results.

Tremendous growth since 2009

TheGerman automotive industry has seen remarkable growth since 2009, partly due to cyclical factors (recovery of US and European markets) but also due to real structural change in the global automotive market (emergence of strong Chinese demand for high-end vehicles). The result has been a rapid acceleration of growth in revenues and profits—not to mention share prices in German automotive manufacturers (Volkswagen, Daimler and BMW). On average, income has risen by more than 60% over the last four years. Operating profits have exploded, soaring from €2 billion in 2009 to €28 billion in 2012. As with most other players in the sector, German auto manufacturers cut their costs and investments during the worst of the crisis in order to protect their results and liquidity. Immediately after, volumes quickly jumped, especially due to Chinese demand. The combination of high production volumes, significantly improved mix (strong Chinese appetite for the very high end) and investment restrictions therefore contributed to record profitability.

The end of the cycle?

However, these groups’ results have not grown since 2011, with some even sliding. On the one hand, it seems that the potential for a recovery in volumes for major automotive markets outside of China has peaked and that, on the other hand, German automotive manufacturers had all begun a sustained investment cycle, limiting their operating leverage potential. The main result is that German manufacturers underperformed the MSCI Auto index for the first six months of the year (-2% vs. +4%) for the first time in at least five years. Volkswagen and BMW were hit particularly hard with -10% and -8%, respectively, whereas Daimler came out better (+12%) due to a particularly favourable product cycle. We believe there are several reasons for such a pronounced underperformance:Europe in freefall. The European market remained sluggish at the beginning of the year (-7% over the first five months) with Germany surprisingly taking a dip itself (-9%) though its market had held up well until then, in line with a solid economic situation (historically low unemployment rate). Germany is clearly a key market for domestic manufacturers with a major share of their sales there (between 15% and 20% of global sales volumes). Meanwhile, France and Italy remain in steep decline (-12% for both), Spain seems to be stabilising somewhat (-6%) whereas the UK confi rmed its special status (+9%).China slowing down. In China, the major news from the beginning of the year was the underperformance of the high-end market. Indeed, whereas automotive sales in China increased by 20% in Q1, high-end vehicle sales grew by only 6%, also a sharp decline compared to previous quarters (>20%). This led markets to question the sustainability of sales in the region, especially at a time when the Chinese government is announcing measures to improve the country’s wealth distribution in order to ease a tense social climate. One of the consequences of this slowdown was the steep drop in exports from Germany, the issue being these sales are extremely profitable (in terms of very high-end sedans and SUVs).US market potential exhausted. After a spectacular rebound in the US market (+40% since 2009), it is worth asking what growth potential remains in this key market for German auto manufacturers. After six months the annualised and seasonally adjusted sales rate appears to have stabilised at 15-15.5 million units (even though June seemed better) versus a 14.5 million unit market last year. We also note that the German manufacturers’ market share reached a historic high of 9% and that they hold slightly more than 50% of the high-end market in the US. Currently, the main risk hinges on whether we will see a resurgence of Japanese manufacturers, which are now favoured by the dramatic depreciation of the yen since the start of the year.Spending rising. Finally, we note that German manufacturers have begun an aggressive investment policy. The investment deficit will likely be overcome after the savings achieved during the worst of the crisis in 2009. We now observe that R&D spending, along with investments, have greatly accelerated, with two major objectives: 1. Financing new technologies, including addressing increasingly stringent emissions standards (i.e., BMW’s i electric programme) and 2. expanding production capacity (new Audi factory in Mexico, BMW in Brazil, Mercedes in Hungary, etc.). Between 2009 and 2013, we expect a 52% increase in R&D spending and an 81% increase in investments by the three German manufacturers.

Is this underperformance chronic?

Is this underperformance chronic? Globally, we are not concerned about market and volume factors. We remain optimistic on the growth potential for the global automobile market, which is likely to continue growing over the coming years, driven by emerging countries and a probable recovery in Europe. We can already see signs of stabilisation today: Europe now sells fewer vehicles than it scraps, a sign that European automobiles are shrinking in number and ageing. Meanwhile, sales of second-hand vehicles appear to have recovered in markets such as France. In addition, we believe the trend in China remains very strong: although coastal areas seem to be saturated at the moment, there is still massive potential in the country’s interior, which could mean a doubling of sales in the region over the long term (which would represent a market twice the size of Europe’s!). In contrast, we admit that the need to significantly increase the pace of investment would restrain the short term potential for improving profit margins in the German auto industry. True, these margins are at historically high levels, notably due to the US and Chinese markets which, all things considered, are faring well. Additional growth potential would theoretically be found in a marked eurozone rebound, but a difficult scenario to bet on in the short term. In this context, our investment strategy consists of reducing our overexposure to this sub-segment by adopting a more neutral position.

Frédéric LABIA, Equity Analysis at Amundi
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