There's Plenty Left in the Tank : European Autos Have More to Give
* Backdrop for auto earnings (and stocks) remains bright: 2016 should be a
good year for European auto earnings – we see global volumes up c4% vs the 1.5%
in 2015. Input costs and FX should be supportive and there are signs European
capacity utilization is nearing a point where pricing may improve. Emerging markets
are a risk with US interest rates rising, but the precipitous falls seen in Russia and
Brazil should mean the pain will be broadly flat in 2016. To reflect the challenging
macro outlook, our stock calls are biased to names with good momentum and
scope for positive surprise (we have Buy ratings on Daimler and Renault). We are
wary of names where top-line growth is likely to be sub-par and margin expansion
limited – we have BMW (TP €72.50) and PSA (TP €12) on Sell. Controversially, we
initiate on VW as Buy/High Risk, TP €163. It will be a while before the bad news
fades, but the combination of growth potential and low valuation looks compelling.
We have a Neutral call on FCA (TP €7.00) and Ferrari (TP €37) as we think
technicals will dominate as the dust settles on the spin-off.
* Rising real incomes and employment provide support for sales growth: We
see conditions for auto sales improving in 2016. Based on our multi-regression
models for Europe and the expertise of our autos colleagues around the globe, we
forecast higher global volume growth vs ’15 (4% vs c1%). In terms of European
auto earnings, lower commodity prices and a weaker euro (our FX strategists have
it falling 5% to the dollar in ‘16) will help. In addition, a modest improvement in
capacity utilization (we have it at 79% in ‘16) also means the pricing environment
should be supportive, especially for carmakers launching new products.
* If auto earnings are going up, then so too are auto stocks: I/B/E/S consensus
for the European carmakers has earnings growing 24% in ’16 and another 15% in
’17. We’ve spent a great deal of time churning numbers to see if the well-worn
adage ‘valuation doesn’t matter for auto stocks’ is true. It is, with earnings
momentum generally being 2-3x (although at times as much as 8x) more important
than valuation (and we found EV/Sales is the best metric). We have developed an
autos investment clock that looks mainly at the interplay between market share and
changes in capacity utilization to determine when to buy. Right now we favour the
spenders or product cycle winners, so our key picks are Daimler and Renault.
* Timeline for tighter emissions control unlikely to change: In the aftermath of
the VW emissions scandal, there has been much media talk of tighter control and
higher associated costs for the carmakers. We don’t see this – model cycles in
Europe are c7 years, which means the product plans for 2021 (the deadline for the
next big jump in fuel efficiency) are already set, so changes now would be
unprecedented and draconian in terms of industry impact. It is worth remembering
the extent to which governments (US & European) have gone to protect jobs in the
auto industry. It is hard to see why they would jeopardise all those efforts now.