Reversal of currency tailwinds to put European earnings at risk; cut estimates and TPs
* European earnings at risk – maintain negative view.
We maintain our negative sector view, as recent RmB devaluation not only cuts margins on China exposure, but also on Europe. Deterioration (normalisation) in Europe's trade balance (major trade currencies depreciated versus the euro) is set to put pressure European earnings due to lower utilisation and overall a more challenging pricing environment. In our view, the market still fails to discount this risk. Estimates cut >10% for the sector, which puts us c.15% below the street. FCA (OP) remains our most preferred name in the sector.
* Europe's trade balance set to deteriorate:
We see material risk to European production and utilisation rates as currency tailwinds on exports are set to reverse/normalise (euro appreciated by c. 8.5% since April lows already). Lower net exports should offset any domestic demand improvement in 2016E, which leaves overall industry utilisation rates at best flat YoY. Worsening supply/demand balance within Europe likely creates more price pressure, which in turn means lower margins.
* Germany to struggle the most.
Supportive currency development combined with strong dynamics in export markets like the UK/US (one-third of total) provided meaningful tailwinds for German OEMs. We see 2015 as a turning point for the German industry, and we expect production in 2016E to decline by 3% YoY driven by lower export volumes, which are unlikely to be
compensated by accelerating domestic demand. Thus, we expect the industry utilisation rate to decline to 82%, which is the lowest since 2009.
* Peaking profit cycle – cutting estimates >10%.
We cut our earnings on average by >10% for the period 2015-2018E to reflect lower assumptions for China and Europe. Our biggest cuts are at PSA/Renault, as both have the highest leverage to the European cycle. Our 2016E estimates put us 15% below the street on average. In our view, the market is overly optimistic on European earnings recovery and underestimates the negative implications from reduced net exports/pricing.