Driving to growth?

14 Mar 2014

The automotive sector has shown impressive outperformance over the last two years. With a 47% increase between 2012 and the end of 2013 compared to Euro Stoxx, automobile companies on the whole have maintained a good level of profitability despite a challenging operating environment.

Opinion

By Caroline De Troyer

This performance has left many asking what the coming year will bring for the sector, so here are some top trends investors need to be aware of for 2014.

Sales in the US
The US market has set new historic highs for light vehicle sales in 2013, when shifted sales reached 15.5m units. Macroeconomic factors such as declining unemployment, widespread credit and attractive lease deals will continue to encourage demand this year.

US car sales also hit new highs, when December inventories reached their highest monthly figure since March 1996. Sales will likely continue to rise in 2014 as European and Asian auto manufacturers plan to add 2.1m additional capacity in North America. However, risks cannot be fully eliminated regarding pricing as incentives tend to increase.

Demand from China
China has been a strong contributor to global volume and a key source of profit for the automotive sector globally over the last few years. We have seen a significant increase in demand recently and this will remain strong across 2014, with premium car prices in particular remaining high.

However, we will probably see a normalisation of China’s growth rate, and we anticipate this will translate to a solid passenger vehicle increase of around 10% this year.

Foreign currency exposure on profits
Investors must also be aware of the potential impacts to automobile profits caused by foreign currency exposure. In short, major currency risks are usually hedged against, and thus impact on profits will be phased over the next three years.

By contrast, however, emerging market currency exposure will have a more immediate and direct impact on profits.

Tighter CO2 regulatory requirements
Tightening environmental regulation will have significant impact on the industry this year, notably in Europe, where targets call for an average of 95g CO2/km by 2020, but also in the US and China.

Automotive manufacturers face significant research and development costs for new powertrain technologies and optimisation of existing combustion engine solutions in order to comply with new rules. Given the industry’s history of poor pricing power, these investments will likely have an impact on profit margins.

German manufacturers will lead the pack
We believe that German automobile manufacturers will lead the pack this year. Here are our top three:

Volkswagen is our preferred stock for this year. It has a large portfolio of brands covering all segments of the market, and being an undisputed European leader it significantly affects pricing on the markets. In summary, we see improving operating profits and margins driven by growth, pricing mix, key launches and structural cost savings, although this will be partly offset by currency headwinds.

Daimler is well positioned to reap the fruits from its product rejuvenation in 2013. The on-going resolution of problems in China (poor product positioning, aggressive incentives, unfavourably structured dealer network, fewer dealerships than competitors), and a positive margin development in the trucks division should also contribute positively to its profits.

BMW is a top pick but one to remain slightly cautious about. Despite its strong management team; heavy investment in order to address 2020 European emissions targets and the downsizing of its range are causes for concern. It has also spent heavily in developing electric and hybrid models, and these investments have yet to translate into market share gains for shareholders.

Caroline De Troyer is a senior equity financial analyst at Candriam Investors Group