Europe’s auto parts manufacturing sector remains under pressure

The European automotive sector has been hit by a succession of negative headlines over the past few months, starting with the second-quarter earnings season and continuing into September. The negative news flow included downward revisions of previous full-year 2024 targets and some idiosyncratic developments with major European car markets and manufacturers. Most of the bad news came from Germany, with a significant drop in new registrations in August and September and negative news flow around three German auto manufacturing majors – Volkswagen, BMW and Mercedes.

After a strong rebound in light vehicle sales in 2023, the pace of car sales growth slowed in the first half of this year, which was in line with our expectations. Nevertheless, all three major regional car markets, China, the United States and the European Union, delivered growth during the first half of 2024, notably +4.4% Year-on-Year in Europe (including the EU, UK and EFTA area), +2.1% YoY in the United States and +6.1% in China.

We envisage a deceleration in car sales during the second half of the year as consumer demand continues to be more muted following the buoyant post-Covid phase. The mixed economic environment with elevated, although declining, interest rates and political and policy uncertainties in multiple prominent geographies aren't helping either. 

Used cars are more attractive again

Furthermore, used cars have become more attractive again after prices started to drop following better stock positions. Taking this industry backdrop into account, in August we reduced our global car sales growth expectations to +1.8% for FY24. However, given the sales statistics in August and September and announcements made by various industry participants over the past few weeks, that forecast may prove optimistic, with market growth ending up in the 0% to +1% territory.

We expect production dynamics to be weak in the second half of this year due to high inventories in the United States and a slowdown in the Electric Vechicle (EV) adoption process in Europe. We anticipate that production volumes will drop by mid-single digits in the second half of this year.

For the full year of 2024, we now anticipate that car manufacturing volumes will decline by low single-digit percentages compared to the flat or slightly positive growth we anticipated earlier this year. We believe that this expected contraction in production volumes will impact auto parts manufacturers' revenue and earnings.

As we have already indicated, the second-quarter results season was mixed for the auto sector, with multiple revisions of initial full-year targets. In our view, car manufacturers have been more affected than car parts manufacturers by the changes in the car market environment this year, including less buoyant EV sales. We believe that one reason for this was a strong comparative base for the major Original Equipment Manufacturers, which benefited from a very favourable commercial and pricing environment in previous years.

Now that the demand overhang has been cleared, these OEMs do not enjoy the same pricing power and will have to rely on operational efficiencies to sustain their current relatively high margins.

We believe that auto parts manufacturers have not experienced the same favourable pricing environment as OEMs in the recent past and have initiated some of the cost-cutting initiatives earlier, putting them in a relatively more defensive position margin-wise. In fact, their guidance revision during the 2Q24 season was relatively measured and not wholesale.

An overall sector weakness

However, the overall sector weakness has also been asserting itself regarding European auto parts manufacturers, with major players like ZF Friedrichshafen (ZFF) and Forvia releasing downward FY24 guidance revisions in late September.

To put things into perspective, ZFF did not change its 4.9-5.4% FY24 EBIT margin guidance during the second quarter earnings release on 1 August but revised it down sharply to 3% to 4% on 27 September, less than two months later. We expect more adjustments to the FY24 targets for auto parts manufacturers during the third-quarter earnings season.

The electrification process has slowed in Europe and the US this year, although it's more resilient in China. There are several reasons for that, including saturation in the early adoption buyers category, lack of infrastructure, the ending of government incentives for consumers in Germany, and prices remaining elevated for electric vehicles against more constrained customer buying power.

Against that weak backdrop, it's worth noting that hybrid cars have been enjoying something of a renaissance this year. Several manufacturers have introduced new plug-in hybrid electric vehicles (PHEVs) to respond to current consumer preferences.

After recent negative headlines and guidance adjustments by the European OEMs, we expect that the 3Q24 earnings season will also have a soft tone for European auto parts manufacturers. They might use this occasion to reduce and calibrate their targets further for the full year. While the second half of 2024 is shaping up to be soft and probably weaker than we expected even right after the recent 2Q24 reporting season, we feel that the current year is a transition one where the electrification surge experiences a sharp slowdown before resuming growth at a more modest pace, with more balanced multi-platform car sales, including ICEs, hybrids and BEVs, potentially in the next couple of years.

With expectations for the third quarter and, indeed, the second half of 2024 being managed significantly lower, we believe the outlook for 2025 is becoming increasingly relevant. For now, we expect a stabilisation in the global auto market volume next year, with some positive aspects more likely than a sharp negative downturn; the expected lower interest rate backdrop in the United States and Europe should provide a tailwind for consumer sentiment.

A reliance on policy support

In the US, for example, 83% of new cars are financed by lease or loans.  At the same time, visibility is still limited for next year, and we feel that auto markets in key geographies may have to rely on some policy support in order for constructive scenarios for the year to materialise. Such policy measures could potentially include new EV subsidies in Europe, including Germany, tailwinds from the economic stimulus measures in China or some supportive measures after the US elections.