Struggling automotive sector is set for recovery
• Recovery of deliveries after diesel scandal provides opportunities in car makers and suppliers • China is likely to stimulate car sector to sustain GDP growth and meet government targets • Near-recession valuations after a difficult 2018 and increasing expectations can help car suppliers
Car makers and suppliers have been struggling this year as the European Union imposed new emission testing standards and Chinese car sales weakened. But the sector may overcome these fundamentals: the impact of new European rules has almost been absorbed and the outlook for next year’s Chinese car sales is becoming positive; even more so if a Chinese stimulus plan will be implemented. At the same time, valuations in the automotive sector are close to recession levels. Therefore, when sales momentum picks up, we expect a potential recovery in the sector and a big boost for car parts suppliers. Nicolas Simar, Lead Portfolio Manager, European Equity Dividend Strategies at NN Investment Partners explains:
A new testing regime in Europe
After the diesel emission scandal, the European Union introduced a new method to measure car emissions and fuel usage. The new Worldwide Harmonised Light Vehicle Test Procedure (WLTP) was put in place after car makers installed software designed to lower emissions from its diesel engines when the car was being tested. The new procedure, which was implemented in the third quarter, required time-consuming testing of every car model. This complicated the process and disrupted the supply chain in the automotive sector. As an example, this process led to Volkswagen having at some point 250,000 cars waiting to be delivered in Germany. Currently, most suppliers have fully adjusted to the new tests and the negative impact on the deliveries has been greatly diminished. This means that next year deliveries most likely will rise compared to 2018 when they were suffering from these disruptions.
China likely to recover in 2019
The other factor that is lowering valuations in the car sector is the disappointing development of the Chinese car sales this year. Over the last months, the decline in sales has accelerated from -4% in July to -12% in September and October. The uncertainty around the impact of the trade war between China and the US and the fall of the Chinese stock market are the main reasons for the decline in car sales. Chinese consumers are anticipating stimulus measures to boost car sales in order to support the Chinese economy. This is likely to lead to consumers postponing car purchase as they await possible subsidies. The automotive industry is an important contributor to Chinese gross domestic product and is likely to be stimulated in order to sustain economic growth in line with the government’s targets. The most widely speculated measure will be a reduction in the purchasing tax for small cars from 10% to 5%. This has proven to be a successful policy in 2016 as well. The expectation is that this may increase the market by 10% in 2019 or close to 2 million cars. This stimulus plan for the Chinese car market is not official yet, but we believe it is highly likely it will be implemented in order to compensate economic pressure from higher trade tariffs at the start of 2019.
Valuations are not discounting any recovery
This year, the automotive sector has been amongst the worst performing sectors in Europe. Stocks of car manufacturers, the original equipment manufacturers (OEMs), have fallen almost 15% since the start of the year and the auto-part suppliers have lost even 35% of their market capitalization (see figure 1). Valuations have fallen dramatically and are close to recession levels as the market seems to extrapolate the slowdown in Chinese car sales while fearing that US and European markets are peaking.
We believe the Chinese market will recover thanks to the stimulus. The US and European markets can sustain their current levels due to higher employment rates and purchasing power due to wage inflation. As long as these regions won’t suffer a recession, their auto markets will be sustainable.
We therefore believe the market is too pessimistic. A recovery in China could boost momentum for global car sales and might lead to a recovery in the shares of the OEMs as well as the suppliers. In an environment of rising sales expectations, stocks of suppliers tend to outperform those of the car makers as they grow faster. The current estimates are not discounting growth in the Chinese car sales in 2019. China accounts for more than 30% of the profits of most car makers and suppliers.
For the NN (L) Euro High Dividend and NN (L) European High Dividend funds, we recently introduced a position in the automobiles sector. In addition, we are overweight automotive suppliers as we expect them to be able to benefit from the recovery in the European and Chinese markets. After a significant de-rating, these stocks offer attractive valuations that are about to approach the levels seen during the last recession. Finally, they offer an above-average dividend income with current dividend yields between 4% and 5%.
NN (L) Euro High Dividend and NN (L) European High Dividend are sub-funds of NN (L) (SICAV) , established in Luxembourg. NN (L) (SICAV) is duly authorised by the Commission de Surveillance du Secteur Financier (CSSF) in Luxembourg. Selected share classes of NN (L) Euro High Dividend are currently registered in Austria, Switzerland, Denmark, Finland, France, Hungary, Luxembourg, Norway, Chili, Belgium, Germany, United Kingdom, Greece, Italy, the Netherlands, Slovakia, Sweden, Spain, Portugal, South Korea, Czech Republic, Singapore, Taiwan, Romania, Peru. Selected share classes of NN (L) European High Dividend are currently registered in Austria, Switzerland, Denmark, Finland, France, Hungary, Luxembourg, Norway, Chili, Belgium, Germany, United Kingdom, Greece, Italy, the Netherlands, Sweden, Spain, Czech Republic, Portugal, Slovakia, Singapore.
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