Bumps ahead for European car shares

Equity investors are expected to stay away from most European auto firms this year as issues from chronic overcapacity to poor demand undermine confidence, though the premium car segment has potential to shine.

Analysts see defensive shares such as telecoms, healthcare and utilities benefiting from a shift away from cyclicals in general, with autos, the worst performer this year, especially hit by a projected 10 percent drop in 2010 car sales volumes.

Valuations of automobile companies have fallen with a drop in equity prices, but are still higher than in many other sectors. A potential downgrade in earnings estimates might push the price-to-earnings ratio up, making stocks more expensive.

The STOXX Europe 600 Automobiles & Parts index trades at 19 times its one-year forward earnings, compared with 10 times for the oil and gas sector, 11 times for banks, 12 times for basic resources and 15 times for the technology sector.

The industry badly needed restructuring, but political considerations such as maintaining jobs during the economic crisis stopped companies working aggressively on that front.

"The situation for the auto industry will remain somewhat difficult and I am not so sure whether short to medium-term investors should enter right now" said Klaus Wiener, head of research at Generali Investments.

"We have structural overcapacity globally. The labour market situation will remain difficult and disposable incomes for households will stay fairly weak. It doesn't bode too well for the car manufacturing industry."

The auto sector is down 12 percent this year, underperforming other sectors like technology sector, up 6 percent, and food and beverages, up 4 percent. 

"This is not a sector to buy and hold," said Philippe Gijsels, head of research at BNP Paribas Fortis Global Markets. "There is way too much capacity and I don't think this is a sector which will generate much profits over the coming years."

DOWNGRADES, DYING INCENTIVES

Generali has downgraded the auto sector to "neutral" from "buy", saying that while the macroeconomic environment remained strong, the sector did not show the expected cyclicality because of the end of some incentives.

February car sales rose sharply in France, Italy and Spain as scrappage programmes helped, but European carmakers face tougher times ahead as governments phase out incentives.

Industry experts say the scrappage schemes would have become less effective even if they had not been phased out.

"Most 10-year-old cars possessed by someone who can afford to buy a new one are gone from this planet forever" said Colin Dodge, Nissan Motor Co Ltd regional chairman.

The schemes limited the fall in European car sales last year to 1.6 percent despite a savage industry crisis. Some incentives have ended, are due to end, or are hanging in limbo, and carmakers fear any hint of an underlying recovery in demand will not be enough to prevent a second sales dip.

Renault's chief executive Carlos Ghosn has said the European car market will fall 10 percent this year.

"A key challenge is to compensate this fall in volumes in Europe with rising sales in other markets, like emerging markets" said Georg Stuerzer, automobile analyst at UniCredit. 

"But people are reluctant to invest in auto stocks. What we are seeing is a move towards defensive sectors, but we also have recommendations within the auto sector."

FOCUS ON PREMIUM SEGMENT

Investors had a preference for premium car makers such as BMW and Daimler, analysts said, adding there has been a rise in global premium demand, driven by strong sales in China, the beginning of a recovery in the United States and a return of banker bonuses.

"I am not very interested in this industry, but there are some good companies within the sector. I have a holding in BMW." said Sebastien Lemonnier, European equity portfolio manager at Tocqueville Finance, which manages about 1.3 billion euros.

"Even though it's a family-controlled company and there is not much to expect in terms of restructuring, there is a new chief executive whose strategy is to reduce cost" he said.

Analysts said BMW's revamped 5-series cars will give better margins as production will be more efficient than in the past.

Toyota's recall of some 8.5 million vehicles due to uncontrolled acceleration and braking glitches has certainly hurt its reputation for quality and resulted in lower sales, but would not have a significant impact on the industry, analysts said.

However, in the near term, a move by Toyota to give heavy discounts to customers in the U.S. and Europe to sell cars might trigger a price war amongst automakers to gain the market share.