European auto stocks may not see an immediate boost following central bank rate cuts, despite hopes for greater affordability of new cars, Morgan Stanley highlighted in a note to clients on Wednesday.
Historically, the industry has not responded quickly to rate cuts, and weak underlying demand, coupled with deflation in new and used car prices, typically takes some time to resolve.
“Lower rates alone cannot save the auto sector,” Morgan Stanley analysts noted in their report, stressing that while reduced rates can boost car affordability, “it may take several quarters for underlying demand to improve.”
As a result, analysts remain cautious on European car manufacturers (OEMs) and see margin risks looming for the sector.
Morgan Stanley’s macro team predicts that the Federal Reserve will make its first rate cut of 25 basis points at the September meeting of the Federal Open Market Committee (FOMC), bringing the policy rate down to 5.125%.
The analysts expect a total of three such cuts before the end of the year. However, the analysts warn that this cheaper money may not be enough to offset the pressures in the auto sector.
The report also highlights that lower rates tend to coincide with lower average selling prices (ASPs) as OEMs seek to defend their market share.
This can help improve affordability, but could present a challenging margin environment. “We already reflect lower rates in our new car affordability estimates, helping, but not completely solving, industry pressures,” the report said.
Additionally, the research shows that OEMs, as credit-sensitive stocks, may not benefit from falling bond yields as much as expected.
“Lower bond yields, while helpful for affordability, may reflect lower aggregate demand and are not always accompanied by tighter spreads,” Morgan Stanley said, while also noting that “more bullish would be signs of reflation in China .”
Morgan Stanley data also shows that European auto stocks underperform when interest rates fall rapidly. “The relative performance of autos averages -7% in months when 10-year bond yields fall by more than 50 basis points,” the report said. This indicates that rising bond yields have historically provided more support to the sector.
As such, the analysts suggest that for investors with a multi-year horizon, the sector’s risk-reward profile remains poor.
“We continue to believe that margin cuts make the risk-return ratio in the sector quite poor,” the report said, warning that the current weak demand environment and high margin estimates still pose risks for European automakers.
Despite the pressure on OEMs, Morgan Stanley’s analysis also addressed the role of inflation. The auto sector had previously benefited from rising prices, but “recent data highlights that the fundamental backdrop for auto prices is now worsening,” with US new car price inflation turning negative and incentives for dealers increasing.
“We continue to see affordability pressures,” Morgan Stanley said, citing weaker underlying demand for new cars at current prices. The report noted that too Bayerische Motoren Werke AG (WA:)’s recent profit warning, which pointed to weak demand, especially in China, as a key factor for margins.
