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  1. Analysis
April 4, 2005

European profitability about to deteriorate again

The big European car companies are going through tough times. Europe’s economy is weak, US export earnings are hit by the weak dollar, there are cost pressures to contend with and competition in Europe is intense. Things can’t get any worse can they? Yes, the Chinese are coming. By Neil Winton.

The big European car companies are going through tough times. Europe’s economy is weak, US export earnings are hit by the weak dollar, there are cost pressures to contend with and competition in Europe is intense. Things can’t get any worse can they? Yes, the Chinese are coming. This report by Neil Winton.

When a company on the crest of a new model wave like BMW is struggling to improve its profits, you know something must be wrong.

It is hard sometimes to realise that car manufacturers tend to be chronically unprofitable. We get used to seeing no-expense spared, lavish displays at car shows. Glossy TV ads show off fantastic new cars which cost fortunes to make, sponsored by some highly paid Hollywood starlet or Football hot-shot. Motoring journalists, car dealers and investment bankers regularly find themselves on the receiving end of celebrity treatment, fuelled by the routine use of private jets, the world’s finest hotels, and the use of ever more exotic locations to launch new cars. None of this suggests that these companies are anything but money-making machines.

Nothing could be further from the truth.

Last year Volkswagen sold more cars than ever before, but profits of the group slipped. The VW brand itself lost about 200 million euros in 2004. Every time Mercedes’ Smart division sold a car last year it lost between €2,800 and €4,000, according to investment banker Morgan Stanley. Fiat makes a loss on every car it sells, says the Financial Times of London.

Only luxury carmaker BMW and sports car manufacturer Porsche make the kind of money which makes accountants and investors smile.

And things will get worse in 2005.

Deutsche Bank’s report on European automakers’ financial reports for 2004 must have sent a shiver through investors in car manufacturers’ shares.

“Somewhat unsurprisingly, the Autos reporting season in Europe was affected by a chilled outlook on raw materials, pricing pressure and flat volumes which are going to take out much of the current year earnings momentum in our view,” said Deutsche Bank.

And there wasn’t much “earnings momentum” there in the first place

European Mass Car Manufacturer Profits

outlook for 2005
Ford Europe loss $1.1 billion profit $114 million +$200 mln max
GM Europe loss $286 million loss $742 million loss $500 million
Fiat Auto loss net loss €1.5 billion loss
Renault   OM 5.9% OM over 4%
Peugeot   OM 4.5% OM 4/4.5%
VW OP €2.3 billion OP €2.02 billion steady at best?
BMW net profit up 14% to record tough to match
Mercedes barely profitable in 2004
first quarter loss?
(OM – operating profit margin)
(OP – operating profit)

Ford Europe managed to cut its more than $1 billion loss in 2003 to a small profit in 2004, and its financial condition was under pressure as sales dived by nearly $1 billion in 2004’s final quarter.  Ford Europe expects another paltry net operating profit of $100 million to $200 million in 2005. GM Europe expects to lose about half a billion dollars in 2005, and although its market share rose early in 2005, most experts believe this was because of increased use of discounts and price cuts.

Fiat Auto lost €1.5 billion in 2004 and will lose money again in 2005 from operations, although the settlement from the ending of the deal with GM might put a temporary gloss on things and drag the numbers into the black. Peugeot’s 2004 net profit fell 9.4 per cent to €1.4 billion, and it expects this to hold steady at best in 2005. Renault’s operating profit jumped 72.5 per cent in 2004 to €2.4 billion, but it expects margins to narrow in 2005.

VW operating profit slid to €2.02 billion in 2004 from €2.3 billion in 2003.  Commerzbank points out that as recently as 2001, VW’s operating profit had reached €5.4 billion, and it doesn’t see VW getting close to this kind of figure any time soon. An almost €1 billion loss in north America and a haemorrhaging of profits in China don’t bode well for 2005 and VW CEO Bernd Pischetsrieder has put a dampener on expectations saying only that, hopefully, profits will be maintained.

Runaway success
BMW, boosted by a highly successful new model campaign led by the 1-Series and the recently renewed 3-Series, is on the crest of a wave. European sales are leaping – up more than 36 per cent in February, but profits are unlikely to improve on last year’s record in 2005, according to CEO Helmut Panke. The weak dollar is undermining BMW.

Mercedes, plagued by out of control warranty costs mainly for the dodgy electronics on the E class and problems at Smart, is expected to have lost up to $500 million in 2005’s first quarter.

The most recent data for Western Europe sales cast more gloom. Sales so far in 2005 are the worst in 10 years, according to investment banker Citigroup. Morgan Stanley said that after February’s sales it might have to cut its forecast for the year.

“We believe our 14.7 million forecast for the market is increasingly at risk,” Morgan Stanley said.

According to Deutsche Bank, the long-awaited car sales recovery in Germany, Europe’s biggest market for cars, may have to be put off again, and said its forecast of 3.3 million sales this year is at risk.

Downbeat Bernd
Volkswagen CEO Bernd Pischetsrieder gave a gloomy forecast for the year in a recent newspaper interview.

“It is not to be expected that the backlog in demand is going to be resolved in the short-term and that automobile sales in Western Europe will rise in the coming years,” Pischetsrieder told Welt am Sonntag.

Car sales are teetering in big markets like Germany because of economic stagnation, with consumers worried about their jobs and economic security.

“I think we are learning that it is not going to get better. It is a different attitude in Western Europe for consumers buying cars. If everyone is concerned about his pension, one area where you can save money the easiest is on cars,” Dresdner Kleinwort Wasserstein analyst Arndt Ellinghorst told Reuters.

And there is increasing competition from Asian manufactures, which now account for about 17 per cent of Europe sales, according to the European Automobile Manufacturers Association. If you don’t want to get your head bitten off by a European car maker, don’t even mention the fact that the Chinese are coming. Brilliance China Automotive is expected to launch its Zhonghua saloon in Europe in September.

It’s not only weak economic conditions that are spooking car manufacturers.

Weak dollar
Raw material costs are on the rise, and the weak dollar has decimated profits for the likes of Mercedes, BMW, and Audi in the U.S. The euro has risen 6 per cent against the dollar since the start of 2004 and 28 per cent since the start of 2003. Some experts expect an average euro value of about $1.35 for the next couple of years.

The combination of weak demand and rising costs is forcing the carmakers to ever more desperate methods of keeping their production lines running. Incentives and price cuts are on the rise. The manufacturers rarely come clean on the extent of their funding of sales, but an example of their desperation came from GM Europe’s Opel/Vauxhall, which announced at the Geneva Car Show in early March that it would be allocating more than 30,000 cars to dealers to offer extended free road tests to prospective customers. Anyone showing an increase in an Opel/Vauxhall could have the use of a vehicle for up to 4 days. But at least sales rose in February for Opel/Vauxhall, with market share in Europe up to 10.5 per cent from 9.8 per cent.

Great new products
Perhaps some investors looking around the Geneva Car Show in March might have thought that with all this gleaming new product on offer, things would turn out all right on the night. Peugeot and Toyota introduced their three new little city cars build jointly in The Czech Republic – the Citroen C1, the Peugeot 107 and Toyota Aygo. There was the new Passat, VW’s most important product for sales and profits. (VW will roll out eight new or updated models in Germany in 2005.) Mercedes unveiled its new B class. BMW’s 3-Series, Fiat’s Croma, and Alfa 159 and Brera took a bow.

But great new products won’t help if the European economy is stagnating.

“I have not got any more confidence, because we have had a couple months of the market being relatively quiet, and that is a concern,” said Ford of Europe Chairman Lewis Booth.

However, pressure will remain on costs, Booth said.

“We are expecting this year to be really tough in Europe. We still don’t see a recovery in the German market at all,” he said.

Neil Winton

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