A question of (price) discipline

Global automotive production typically grows at a similar level as the global GDP - yet we have seen a decoupling of this long-term trend since 2019. However, the growth prospects of the global automotive sector have not changed structurally, they have rather come under pressure due to a combination of different circumstances.

Global car production

Let's take the 2020 Corona breakout as a starting point - here, after the sharp slump, the rapid recovery was initially massively underestimated by the industry and orders for supplier parts, including semiconductors, were significantly reduced. The semiconductor industry rerouted the free capacities to other industries booming mainly due to the home office trend, such as the PC and electronics industries. Thus, the "perfect storm" was programmed for the automotive supply chains, and access to the required capacities was lost. This theme has been a common thread running through the automotive industry since 2021 and is the main reason for the various production cuts over the past 18 months. To date, the industry remains in a state of artificially reduced production volumes, although the situation is now gradually improving.

The supply chain issue has facilitated the automotive industry unprecedented price discipline (no discounts!), which is reflected in massively increased used and new car prices, among other things. For many carmakers, limited supply and booming demand have helped them achieve record margins - Mercedes, for example, even felt compelled to declare an order freeze for the E-Class in February due to the strong demand and long delivery times - an absolute first.

Information on semiconductor supply chains, based both on personal discussions with industry representatives and on inventory data, has recently pointed to a significant easing in the market. Production constraints are currently relatedausfallen to a relatively small number of components, such as microcontrollers, while significant inventory levels are now back in many other areas. Supply chain bottlenecks should thus improve significantly over the course of the second half of the year and 2023.

However, with volume recovery potentially on the horizon, various questions loom large: Has the industry learned from past mistakes and is the current pricing discipline sustainable? To what extent do catch-up effects from candelled production in recent years support demand? What role does an increasingly likely recession play in this scenario?

Margins will come under pressure

Contrary to various assurances by the automotive industry, we assume that in a scenario in which supply is no longer limited, price discipline will also abruptly disappear again and the margins of car manufacturers will come under significant pressure. This will be the case for volume manufacturers in particular. In the past, however, luxury brands or even the top-of-the-range models of premium manufacturers have had fewer problems maintaining their margin levels.

The current relatively low level of production, the pent-up demand in recent years and the increasing average age of car fleets in the USA and Europe should have a supporting effect. In addition, the operating leverage in higher production volumes and efficiency gains in the wake of the supply chain chaos should also help.

The increasingly realistic recession scenario in Europe and potentially also in America has a significant dampening effect on volume recovery in perspective. Automotive demand is traditionally highly cyclical - a classic "discretionary consumer good" that also carries a high price tag in absolute terms. As a result, there is a quick risk that such spending will be postponed.

Even though the order books of the automotive groups are currently still very well filled, the first signs of a potential downturn are becoming visible. Volkswagen, for example, is seeing the first signs of weakening demand in Europe. Classic indicators for consumer goods, such as consumer confidence, also currently look highly unfavorable for the sector.

Gas supply in the German automotive industry

For car producers in Germany, which by now also include Tesla, there is an additional issue that could cause distortions - the gas supply to the industry, which could be rationed by the state if the Russian supply freeze continues.

At first glance, the German automotive industry's direct dependence on gas is relatively manageable in terms of consumption data and costs. Volkswagen, for example, is energy self-sufficient with its own renewable energies and its own coal-fired power plant in Wolfsburg, but the devil is in the details. If there are significant restrictions in gas supply, it can be assumed that some affected suppliers, such as the chemical industry, will have problems and thus manufacturers will again have to deal with supply chain problems.

E-mobility continues to advance

Away from the currently controversial recession and gas supply issues, the European Union's long-term decarbonization plans are also making further progress. At the end of June, as part of the "Fit for 55" program, it was decided to effectively phase out internal combustion engines for new vehicles from 2035 on, thus further strengthening the path already taken towards the electrification of fleets. Potential exceptions here could still be the use of e-fuels, which were explicitly left open.

Automotive stocks more interesting selectively than across the board

The automotive stocks and the European automotive sector have meanwhile fallen by around 30% since the high for the year in January. In view of a possible recession in Europe, the decline in share prices has so far been moderate in historical terms (measured against recessions since 1990). On average, the price drop from pre-recession highs to recession lows in the automotive sector is close to 53% - thus, historically speaking, the technical lows have not yet been reached.

In general, caution is advised in a recessionary scenario in cyclical sectors, especially as analysts' estimates for next year could well turn out to be too optimistic in the automotive sector. Thus, selective investments in the sector are more advisable than across the board.

Automotive manufacturers versus suppliers

Automotive supplier stocks have significantly underperformed relative to automaker stocks over the past 24 months due to the lack of pricing power and thus offer perceived catch-up potential. However, we believe it is too early for this due to the presumably impending recession, even if the easing of semiconductor supply chains, viewed in isolation, argue for a volume recovery.

In the case of interest-sensitive companies with a start-up character, i.e. with high valuations and no significant earnings, skepticism remains warranted even after significant share price discounts in the current market environment. Strong balance sheets, which most German automotive groups have, are a great advantage in turbulent times, as they can also be used for share buybacks (see e.g. BMW). 

Values with company-specific special situations can often develop differently than the overall market. An example of this is Porsche Holding AG - the holding company of the Porsche and Piëch families, which trades at a discount of 31% to its intrinsic value (net asset value). This value is primarily made up of almost 32% of Volkswagen shares and a net cash position. The upcoming IPO of Porsche AG, i.e. Porsche's operating automotive business, may make this discount to intrinsic value more transparent.

What is important in an inflationary environment - as in all industries - is strong pricing power. This is found less with volume manufacturers, but more so with luxury manufacturers.


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