Car Industry Faces Brexit Breakdown

(Bloomberg) -- You almost have to pity Europe's carmakers. Sales were really beginning to purr again on the continent after a torrid period during which overstretched consumers stopped spending.

EU car sales rose more than 9 percent in 2015 and increased by a similar amount in the first five months of this year. Profits recovered. French carmaker Peugeot, for whom Europe accounts for about 63 percent of vehicle sales, achieved a 5 percent operating margin last year -- decent for a mass-market manufacturer.

Yet after a sharp-sell off last week, investors are on average now willing to pay only about 5.8 times the estimated forward earnings of European auto stocks.  

Normally, such bearishness might prompt bargain-hunting. But in this case, the understandable fears about British and European consumer spending suggest auto-maker earnings expectations are probably still inflated.

Thomas Besson, an analyst at Kepler Cheuvreux, has cut his 2017 EPS estimates for BMW and Daimler by 8 percent and 9.5 per cent respectively. He lowered his forecast for Peugeot's 2017 EPS by 18.4 percent. If carmakers are forced to issue profit warnings, auto stocks won't look so cheap.

There are plenty of reasons to think trouble lies ahead. The U.K. is Europe's second-biggest car market and -- as Gadfly warned before the referendum -- it's a profitable place to sell motor vehicles. Thanks to the popularity of leasing, British buyers drive cars they might otherwise struggle to afford. Premium models with lots of add-ons earn higher margins.

With a question over London's finance sector jobs, it's difficult to imagine British punters thinking now's the time to splash out on a prestige motor. Carmakers who export lots of vehicles into the U.K., such as Peugeot, face a double hit to revenue because of the weak pound. Then there's the risk that Britain's hara-kiri vote undermines confidence elsewhere in Europe too. With discounting already at high levels, European carmakers don't have much room to slash prices to prop up sales.

In the past, auto-makers could offset Europe's weakness with growth elsewhere, notably the U.S. and China. But neither looks ready to help them offset the Brexit blues right now. While a strong dollar helps those with U.S. sales exposure, such as Daimler and BMW, the American autos market looks saturated.

Investors are rightly concerned that low interest rates have encouraged U.S. dealers to push sales too hard. That could hit residual values when a flood of nearly-new cars hits the second-hand market. BMW has already taken action to cut excess U.S. inventory in anticipation of tougher conditions.

And while tax cuts have helped sales in China -- which increased 11 percent year-or-year in May -- competition has intensified. If government stimulus is withdrawn and China's debt problems worsen, car sales there could fall too.

The Volkswagen scandal certainly hasn't helped, putting pressure on companies to spend more on compliance and sparking fears that sector profit has peaked. After the industry's recent tear along the autobahn, Brexit may well have slammed on the brakes.

This column does not necessarily reflect the opinion of Bloomberg LP and its owners.

To contact the author of this story: Chris Bryant in Frankfurt at cbryant32@bloomberg.net.

To contact the editor responsible for this story: James Boxell at jboxell@bloomberg.net.