Positive momentum surrounding the major European autos continues to gather pace. The past week in particular has seen a number of encouraging stories emerge from the sector. Firstly, BMW and Daimler both underscored the recovery in the premium auto market by announcing an increase in their earnings guidance for the full year 2010. BMW sold 13% more cars during the first six months of the year compared to the same period last year. It now expects sales volumes to rise by around 10% to more than 1.4 million units for 2010, up from a previous target of 1.3 million units. Crucially BMW also raised one of the key measures for its auto division. The EBIT margin in this segment is now forecast to reach over 5%, up from previous guidance that the margin would climb within the low single-digit percentage range. For Daimler, its luxury Mercedes-Benz division has powered a strong Q2 performance. As such, the company announced it will increase its EBIT guidance for 2010 as part of its second quarter report due out on 27th July, 2010.

Adding to the upbeat tone, Fitch signalled an inflection point in the credit profiles of European auto manufacturers by taking positive rating action on four auto names, the first we have seen in the sector for some time. The rating agency revised the rating outlooks on both Peugeot (BB+) and Renault (BB) to stable from negative. The outlook on Daimler (BBB+) was revised to positive from negative and that on Volkswagen (BBB+) was revised to positive from stable. Fitch commented that this reflected the continuous improvement in European original equipment manufacturers’ financial profiles since 2009, the faster-than-anticipated recovery in global auto sales and the rating agency’s revised expectations for key credit metrics in the next couple of years.

This news bodes well for Q2 earnings from the sector due to be released over the next two weeks. A rise in auto demand coupled with an improvement in the sales mix (i.e. increased demand for larger cars with a higher profit margin) should ensure that both revenues and profitability have risen in H110 YoY for most manufacturers. Those autos with exposure to emerging markets, in particular China and Brazil, are likely to report the largest gains. Auto demand in China and Latin America rose by 27% and 11% YoY respectively in H110, leading the overall rise in global auto demand of 13% over the same period. Higher profitability should also feed through into higher cash flow, which will continue to support solid liquidity in the sector.

Major European auto sales

Source: Company data.

However, although the European automakers are clearly on firmer ground, the second half of 2010 could be much tougher. Indeed, aside from headline Q2 figures, investors will be firmly focused on the automakers’ outlook statements provided with the results. In particular, demand in Europe could decelerate over H210 as the market feels the full impact of the withdrawal of government incentive schemes. This is worrying for those European autos that rely on their domestic market, although sales further afield look set to hold up well. Consumer confidence could also be impacted by austerity measures or any negative economic developments. And the sector also remains vulnerable to any further contraction in the availability of financing if problems persist in the banking sector. More importantly, factors that plagued the sector before the credit crisis have still not been resolved. While recent events have removed some capacity from the US auto market (e.g. the tie up of Fiat and Chrysler, the streamlining of operations at GM and Ford), structural overcapacity continues to be a significant problem in the European market, which will see competition remain intense. Profitability will also be weighed down by costs to develop new models to meet increasingly strict environmental regulations. While it is unlikely that any of the major European autos will experience a significant decline in their financial performance over H210, these factors are likely to mean that improvement will slow over the next six months. In terms of individual autos performance, our view remains unchanged. We think the premium end manufacturers, such as Daimler and BMW, remain the best placed going into H210 and will be able to weather any further volatility in the market. And it is these automakers, as opposed to their mass market peers, that are likely to experience the bulk of any further positive rating action in the sector over the next six to twelve months.

Nicola Sanders - Credit Analyst

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