Equities: is the automobile sector in turmoil?

On 27 February, the Federal Court in Leipzig confirmed that Germany's large cities henceforth had the right to ban the use of diesel cars (considered as polluting) in their jurisdiction. Stuttgart and Düsseldorf wanted to prohibit the oldest diesel cars from their respective city centres, but some Länders, fearing a negative effect on employment in the car industry, referred the case to the Federal Court.

This decision is obviously good news for the air quality (reduction of fine particles), but less so for the automotive industry. Although the decision of the Leipzig Court is not a rule for the whole of Germany, it highlights an increasingly drastic regulation in terms of emissions, which may cause a headache for car manufacturers in future. The possible succession of political decisions in fact gives the impression of an accelerating disruption in the sector. The market is undergoing a profound transformation: diesel today accounts for only 40% of sales in Europe (versus more than 50% in 2016).  Manufacturers must therefore adapt to the new context. Some are making a successful turn towards electric cars, but competition is fierce in this segment. At this stage, it is difficult to say who will be the winners over the next decade.

In addition, other factors call for caution in the sector:

• A revival of protectionism in the United States. This subject is dominating the news in several ways. First of all, the renegotiation of the terms of the North American Free Trade Agreement (NAFTA) between the United States, Mexico and Canada is still under discussion. The automotive industry, which is a central topic, could face regulatory changes. Secondly, President Trump has announced, as part of his trade policy, the introduction of new tariffs on steel and aluminium imports into the United States. The measure could have a direct impact on the cost of manufacturing vehicles on home soil. Finally, President Trump plans to rebalance import duties in the automotive industry between Europe and the United States. The difference is apparent: a 10% tax levied on American vehicles entering Europe compared with 2.5% for European cars imported into the US. This decision would mainly penalise German manufacturers.
• A less rosy economic climate than in 2017. The car sales cycle is very advanced in many countries. In North America, Great Britain and China, the market is already mature. Only in Europe could sales potentially grow further. In addition, the rise in interest rates, particularly in the United States, is penalising the sector, because credit conditions are de facto less favourable.
• Unattractive valuations. The consumer sector has been largely played by stock market investors in recent years. Valuations are not always attractive, especially in the United States. The sector in the US is trading at 11x earnings, well above its historical average.

In these conditions, it is preferable to maintain a cautious stance on the automotive industry, despite the buoyant environment for cyclical stocks (especially for Industrials and Materials) thanks to solid economic growth. The automotive sector has underperformed since the renewed volatility in February.