The European car market is on the slide this year and much of the gloom appears to emanate from weak economic growth and sluggish demand in Germany. In the face of a fragile European economy, the ECB has just lowered interest rates to a record low 2%. But maybe there is light at the end of the tunnel. Neil Winton surveys investment banks and analysts for views.
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It’s a bit like watching the climax of a penalty shootout in the European Champions League Final. Your team needs just one goal for victory, just one perfect strike for glory. Unfortunately, Gerhard Schroeder waddles up to take it. The European car market is on the slide, and the only way it can be restored to heath in the short term, according to analysts and forecasters, is a sudden resurgence of long moribund German demand.
But with the European economy tottering towards recession, and the euro’s rally to dizzying heights threatening to torpedo rich export markets for BMW, Porsche, Mercedes and Volkswagen, it takes a great leap of faith to see Germany leading this turnaround.
For 2003, forecasts for the scale of Europe’s sales slump range up to minus 6 per cent. For 2004, most experts are pointing, with varying degrees of confidence, to a tentative rally, centred on Germany.
Experts searching for evidence to back this idea point to the avalanche of fabulous new models which will be launched later this year – the new BMW 5, VW Golf; the Opel Astra? And don’t forget, they say, Germany has been under-performing for years, there’s so much pent-up demand, it’s bound to burst into the open soon, isn’t it?
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By GlobalDataJohn Lawson, European auto analyst for Schroder Salomon Smith Barney (SSSB), agrees that the outlook is challenging, but that all is not yet lost.
“The recovery is being frustratingly slow, but don’t forget we are in the third year of decline in the European car market, and the economics would have to be pretty poor to go much further down from here. All the evidence still points to a recovery in 2004, but expectations of the speed of the pickup have been disappointed by general weakness in the global economy and consumer confidence,” Lawson said.
SSSB believes that European economic growth will be a sickly 0.7 per cent in 2003, similar to 2002’s anaemic 0.8 per cent, but will rebound next year to a relatively powerful 1.8 per cent. This will propel car sales in 2004 to 14.5 million, a 4 per cent gain.
Leap of faith
Lawson concedes that this forecast relies on a leap of faith for Germany. “It clearly does look very difficult indeed. Germany has been more taken out by the euro’s performance than by any of the other economies, and at the same time the dollar’s weakness has had a much more immediate impact on the profitability of the vehicle makers,” Lawson said.
Charles Young, director of research for J.D. Power-LMC, believes that Germany holds the key to recovery, but worries that continued high unemployment and shaky consumer confidence in Europe’s biggest market may thwart the long-delayed resurgence in car sales.
“All of us have been looking for an imminent turnaround in Germany for an embarrassingly long time,” said Young. But that point is nigh, according to Young.
German rally
Young expects German sales, currently at a stagnant annual rate of 3.1 million to leap ahead in 2004 to 3.4 million. If this happens, the European market will increase by about 2 per cent next year. Nigel Griffiths, manager of Global Insight’s European Car and Light Commercial Vehicle Forecasting Practice, expects European sales to drop 4 per cent this year to 13.8 million, bringing the market down about 1.3 million from its 1999 peak. He agrees that Germany is the key to recovery.
“Germany has been crawling along the bottom, it’s been below trend for three years, but wages are rising much faster than car prices, so affordability has improved quite significantly. Sales have not taken off yet because of shaken consumer confidence and rising unemployment,” Griffiths said.
“2004 should see quite a big Germany, with the product explosion later this year, and providing there is not continued deterioration in unemployment next year, should grow above 5 per cent, some say up to 10 per cent,” Griffiths added.
With 5 per cent growth in Germany, Europe should be able to manage about a 1 per cent improvement, Griffiths said, 2 per cent if Germany reaches the higher number. But he warns that if the euro continues its powerful rally, all bets are off.
‘Alarming’ economic developments
And there are some alarming developments in Germany in particular and Europe in general. Deutsche Bank economists say Europe is threatened by a recession. According to Morgan Stanley, the rise of the euro will push Germany into outright deflation, as exports are priced out of markets like the U.S. So far this year, the euro has rise about 17 per cent against the dollar. But Morgan Stanley believes that there is strong evidence to show that the dollar has fallen about as far as it is going to, citing expectations that the European Central Bank will cut interest rates further, and that the euro is already overvalued by about 10 per cent. Europe’s current key lending rate is at a record low 2 per cent after a half a percentage point reduction on June 5.
But other economists are not so sure. Economist Tim Lee, author of an upcoming book “Why the Markets Went Crazy”, said in a recent Financial Times article that the reverse is likely to be true.
“Investors should now be prepared for the dollar’s fall to go much further than they might have thought possible,” Lee said.
Those days are over
However far the dollar may fall, it seems unlikely that the exceptionally favourable conditions for the European carmakers will ever return.
SSSB’s John Lawson said he is sanguine about sales growth developments, but nervous about the impact of exchange rates. “The exchange rate impact is immediate and tangible with big ramifications and exposes the fact that Europe has been gaining windfall profits and enjoying a period of huge prosperity in North America which is not sustainable and will have a big corporate impact,” Lawson said.
BMW 3 Series to be made in America?
This could force some carmakers into some tough decisions, with perhaps BMW thinking about moving production of the 3 series car to its Spartanburg factory in South Carolina, according to Lawson. According to Commerzbank Securities, Porsche derived around 60 per cent of its profits from North America in 2002, from 42 per cent of sales. 40 per cent of BMW profits came from North America in 2002 from 26 per cent of sales, while VW generated around 20 per cent of its profits there last year, from 13 per cent of overall sales.
Hedging
Adam Collins, European Auto analyst for Commerzbank, said that German manufacturers Porsche, BMW, and Mercedes have guarded their U.S. profits by varying degrees of foreign currency hedging. In an ideal world, they would turn to their home market to seek more profits.
Collins said that indeed, pent up demand existed in Germany. The average car was now 7-1/2 years old. But Collins felt that the overall economic situation threatened to undermine the health of the German economy, and the outlook for car buying. Keith Hayes, European auto analyst at Goldman Sachs points out that gloom and doom merchants were wrong because current European sales are at a reasonably healthy level.
Lower interest rates will help
“Sales (in Europe) were 14.3 million last year, that was very healthy, not a boom, but compare that with the early 1990s when sales fell to 11.8 million, now that was a slump; this is quite healthy compared to that. I expect European interest rates to come down and we’re likely to have almost negative real interest rates. If that happens and doesn’t charge up car sales I don’t know what will,” Hayes said.
“The euro’s strength has exposed a whole heap of problems. BMW and Porsche have bought some time with good hedging, but VW is much more vulnerable. Reducing interest rates in Europe will mean fairly robust growth next year, if you get GNP growth of 2 per cent then these (car) markets will recover,” Hayes said.
Hayes also waits to see evidence of German pent up demand. “Trying to forecast pent-up demand is a bit like predicting the weather. You know a front is coming but it is often difficult to say exactly when. German is, after all, 14 to 15 per cent below the long-term trend line. That’s where you get your leverage. The replacement cycle is beginning to build in Germany, but it’s very tough to predict when that kicks in,” Hayes said.
It may well be that German Chancellor Schroeder would execute the perfect penalty kick and send the fans into deliriums of joy, but perhaps you wouldn’t bet your house on it.
