European car sales were up 18% in the first half of the year, but you wouldn’t guess it when looking at how cheaply the region’s carmakers are valued. Most auto majors are traded at less than half of analysts’ fair value estimates. The first take-away would be that the time is ripe to buy quality stopcks at bargain-basement prices– but the situation is a bit more complicated.
What’s holding back sentiment on these stocks is the outlook for consumer demand in the coming quarters. Contrary to the latest sales stats, new orders for cars are pointing to a decline. Consumers are hesitant because of high inflation and the real risk of an economic recession in the second half of 2023.
Morningstar’s automotive analyst Richard Hilgert has been covering this industry for two decades. He attributes recent strong sales to the delayed delivery of orders that could not be fulfilled amid shortages in chips and other components that crimped car production during the pandemic. As these disruptive effects eased, orders placed in a more positive economic climate could finally be filled. As a result, the European Automobile Manufacturers’ Association (ACEA) was able to log growth in new registrations ranging from 11,3% in January to an impressive 28,8% in March.
That resulted in a 17,9% year-on-year rise in the first half year. Most of Europe’s largest markets grew significantly, with Spanish new registrations up 24%, Italy up 22.8%, France up 15.3%, and Germany up 12.8%.
Now that car manufacturers have filled much of the backlog, new demand must replenish order books– which it has not. The German industry group VDA (Verband der Automobilindustrie) observed a decline of 27% in new orders during the first half of the year among its German members. International orders for German manufacturers were down just 5% for the period, but with a downward trend, culminating in a 12% slump for the month of June.
This hesitation consumers feel, is caused by the high inflation that makes household choices move away from deciding for a new car. Retail prices have risen significantly, with the average price tag of new cars sold in the Netherlands now well over 40.000 euros. And on top of that, rising interest rates make financing for a car much more expensive.
This slowdown will result in an expected car sales growth in Europe + UK of between 1-5% in full 2023, according to Hilgert’s predictions. He expects the demand to rise again after the recession fears have peaked and the economic slowdown has bottomed. From 2024 onwards into 2025 he sees demand rising again and registrations growing from 12,8 million cars in 2023 to 15,8 million in 2027.
Production will rise too. “Production levels at the car manufacturers are still relatively low at the moment. We are now in the 4th year of constrained production”, Hilgert says. Compared to 2019, the last full year before covid, volumes in the first half of 2023 were 21% lower, according to ACEA data. That is mainly because the chip industry can’t deliver what the automotive industry needs, Hilgert points out. If the chip industry will expand its capacity and strengthens or builds local supply chains, car production can ramp up.
When the industry reaches the point where production and deliveries are matching demand, revenues and profits will grow towards levels that are implied by Morningstar’s current Fair Value levels. The current valuation levels of the automotive industry in the market are caused by the long-standing effects of the covid-disruption: in the first half of 2021 automotive stocks rallied anticipating a higher demand and production. As that didn’t materialize for the reasons mentioned, a sell-off followed in the first quarter of 2022. And there we arrive where we are today, with for example Volkswagen’s share price at around 125 euros and its Fair Value at 338. BMW is one of Hilgert’s top picks together with General Motors, and shows on Germany’s Frankfurt Stock Exchange 106 euros compared to a 157 euros Fair Value.
So is automotive undervalued? From a Morningstar view, the demand dip that started in 2022 has caused significant discounts. Analyst Hilgert adds: “The market predicts a stronger demand, but we have yet to see that happening. There is a clear path towards higher demand and if that materializes, stocks will go up again. If demand for cars peaks by 2025, and there is no stimulus to keep demand growing, then we will see the stocks in a sell-off again.”
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