Stock Market News – As Geneva Motor Show gets underway, trade tariffs and decline of diesel weighs on outlook for European auto stocks

Raffi Boyadjian, XM Investment Research Desk

As the world’s largest motor show gets underway in Geneva this week, European car makers are using the event to showcase their latest hybrid and electric vehicles in a bid to reassert their place in the future of the car industry. European car manufacturers are seen to be lagging in the race for electric or zero-emission vehicles. The German car industry, in particular, had become reliant on diesel technology. But following the Volkswagen emissions scandal, the future of diesel cars is in doubt.  Adding to European car producers’ woes is the growing risk of tariffs by the United States.

Shares in European automotive companies fell sharply last week after US President Trump threatened to respond to any EU retaliation to his decision to slap tariffs on steel and aluminium with a counter retaliation by placing tariffs on European car exports. Hopes that Trump could be swayed to change his mind about the trade tariffs briefly helped auto stocks recoup some of their losses earlier this week. Those hopes are now fading, but as big if not a bigger problem is the fast-evolving industry where new entrants like Tesla are threatening to erode the market share of traditional brands such as Volkswagen and BMW.

US auto maker, Tesla, revolutionized the industry with its electric vehicles, which leads the competition in terms of battery performance and motor power. Tesla shares have skyrocketed by 1740% since the company’s IPO in 2010. Chinese manufacturers are also making their mark as sales of plug-in electric vehicles (PEV) in China soar. However, although electric or hybrid vehicles are also seeing strong demand in Europe, the region’s manufacturers have been late in the game as big producers such as Volkswagen had put their bets on clean diesel engines driving the future.

The share price of Volkswagen group, which apart from the namesake includes brands like Audi, Seat and Skoda in its portfolio, plunged by 68% during 2015 after it emerged that the company had been using illegal software to cheat the results of emission tests. The subsequent fallout lead to large-scale vehicle recalls and a total pay-out of more than $25 billion in penalties and compensation. The more longer-term impact though has been on diesel technology, which many now see it as dead.

Sales of diesel cars in Europe fell sharply in 2016, forcing German producers to rethink their strategy. Although this isn’t preventing Volkswagen from hoping for a revival. Talking at the Geneva Motor Show, the company’s CEO Matthias Mueller said “Diesel will see a renaissance in the not-too-distant future because people who drove diesels will realize that it was a very comfortable drive concept”. He may be right as diesel car sales rebounded by 10% in 2017.

However, a turnaround in sales is unlikely to save diesel engines as governments and local authorities get tough on diesel cars. A German court in February ruled that German cities are allowed to ban older polluting diesel cars from entering certain streets. It follows similar restrictions by other major cities; Paris and London both plan to completely ban diesel cars in some areas by 2020.

Adding to the pressure on the car industry are CO2 emission targets set by the European Union. Ambitious industry goals to reduce vehicle emissions means European auto makers don’t have the luxury of falling back on petrol/gasoline engines. Although diesel engines emit more toxic nitrogen oxides than petrol ones, their greater fuel efficiency means they produce less carbon dioxide overall. Substituting sales of diesel cars with petrol-powered vehicles would therefore make it harder for manufacturers to meet their targets.

This raises the stakes in the race to develop and mass produce zero-emission vehicles. Recent indications suggest European car producers are rising to the challenge of an electric future and upping their game. Volkswagen unveiled its I.D. Vizzion concept car – an electric self-driving car that uses augmented reality – at the Geneva Motor Show. Its sister Audi brand is planning to reveal an all-electric SUV (sport utility vehicle) in the summer. Luxury car maker Daimler (parent of Mercedes-Benz) has 10 electric models in the works, while its rival BMW is planning on rolling out 12 electric models between now and 2025. Porsche is also joining the electric bandwagon and is developing battery-powered cars to add to its hybrid range.

But the competition is heating up as India’s Tata motors jumped ahead of the queue by unveiling last week the production version of the Jaguar I-Pace all-electric SUV, going head to head with Tesla. Meanwhile, Sweden’s Volvo, now owned by China’s Geely Holding, has pledged to produce only hybrid or electric cars by 2019. Japanese manufacturers are also shifting their focus to fuel-free engines, with Toyota announcing this week that it will phase out diesel cars in Europe by the end of 2018.

However, despite the changing face of the industry and what’s to come, the share price of car manufacturers has so far been more reflective of current performance. Volkswagen’s share price has recovered 40% of the losses triggered by the emissions scandal as sales held up relatively well. While not at the top of the league, its shares managed to rise by 24% in 2017. BMW’s stock price has been underperforming (down 2% in 2017) as its revenue growth has been relatively sluggish over the past two years. Daimler’s revenue growth has been much more solid, though its shares were largely unchanged in 2017.

Looking at other European manufacturers, French car makers Peugeot and Renault are experiencing a bit of a sales surge on their new SUV ranges, though their share prices have risen only modestly over the past year. Italy’s Fiat Chrysler Automobiles was a surprise winner in 2017, whose share price soared by 70%. However, the rally was mainly on the back of a successful turnaround strategy and speculation of a takeover target than exceptional earnings performance.

US auto makers aren’t doing any better. General Motors’ shares were up 18% in 2017 on a stronger product line and on plans to launch 20 new electric cars by 2023. Ford Motor didn’t fare as well, whose shares underperformed, rising by just 3% in 2017 on disappointing profits. The company has only recently started to ramp up investment in electric vehicles. In contrast, Tesla’s stock price surged by 45% last year as it continues to report double digit revenue growth.

As established car makers finally step up their efforts to produce fuel efficient and zero emission cars, it will be interesting to see who will survive and who will come out at the top of the pack in five to ten years’ time. One thing’s for sure, profit margins are likely to be squeezed as electric cars have higher production and development costs. This points to further consolidation in the sector down to line and the first tie-up looks set to come from Renault and Nissan. According to a Reuters report on Wednesday, Japan’s Nissan is in talks to acquire the French government’s 15% stake in Renault, paving the way for a possible full merger.