EMEA Equity Research

European autos abc

July 2012

Autos
European autos team
Horst Schneider*
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3285 horst.schneider@hsbc.de
Niels Fehre*, CFA
Analyst
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 3426 niels.fehre@hsbc.de

Sector sales
Rod Turnbull
Specialist Sales
HSBC Bank Plc
+44 20 7991 5363 rod.turnbull@hsbcib.com
Billal Ismail
Specialist Sales
HSBC Bank Plc
+44 20 7991 5362 billal.ismail@hsbcib.com
Oliver Magis
Specialist Sales
HSBC Trinkaus & Burkhardt AG, Germany
+49 211 910 4402 oliver.magis@hsbc.de

*Employed by a non-US affiliate of HSBC Securities (USA) Inc, and is not registered/qualified pursuant to FINRA regulations

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Sector structure

July 2012
European autos
EMEA Equity Research
Autos

Car makers Auto components

Diversified/multi-product
Mass-market car makers Premium car makers Tyre makers
suppliers

Fiat + Chrysler Audi (Volkswagen) Bosch* Continental

PSA Peugeot Citroen BMW Continental Michelin
Renault Mercedes-Benz (Daimler) Faurecia Nokian Renkaat
Volkswagen brand Porsche (Volkswagen) ThyssenKrupp Pirelli
Ford Ferrari, Maserati (Fiat Valeo Goodyear/ Sumitomo
Group)
General Motors Delphi Cooper
Aston Martin*
Honda Magna Bridgestone
Jaguar–Landrover (Tata
Nissan Johnson Control Yokohama
Motors)
Suzuki Lear Hankook
Cadillac (GM)
Toyota Denso
Lincoln (Ford)
Hyundai–Kia Aisin Seiki
Acura (Honda)
Beijing Automotive*
Infiniti (Nissan)
Changan Group Specialised suppliers
Lexus (Toyota) (telematics, safety,
First Auto Works (FAW ) electricals, chassis etc.)
Volvo (Geely)
Dongfeng
Autoliv
SAIC
Elringklinger
Leoni

abc
*Private companies Magneti Marelli (Fiat)
Rheinmetall
ZF group*
TRW Automotive

Source: HSBC
 Sector price history: Euro STOXX Auto and Parts

July 2012
European autos
EMEA Equity Research
450 Financial crisis & Lehman collapse Greek crisis, sharp rise in oil
prices
End of incentives
400
Early 2000: Impact of 9/11
and bursting of dotcom Car scrappage
bubble schemes
350
Strong recovery in mid
2000s

300
Boom in the 1990s

250
Europe recession

200

150

100

50
Jan-90
Jul-90
Jan-91
Jul-91
Jan-92
Jul-92
Jan-93
Jul-93
Jan-94
Jul-94
Jan-95
Jul-95
Jan-96
Jul-96
Jan-97
Jul-97
Jan-98
Jul-98
Jan-99
Jul-99
Jan-00
Jul-00
Jan-01
Jul-01
Jan-02
Jul-02
Jan-03
Jul-03
Jan-04
Jul-04
Jan-05
Jul-05
Jan-06
Jul-06
Jan-07
Jul-07
Jan-08
Jul-08
Jan-09
Jul-09
Jan-10
Jul-10
Jan-11
Jul-11
Jan-12
Euro STOXX Auto & Parts Index
Source: Thomson Reuters Datastream, HSBC

abc
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EBIT margin versus asset turnover (2007-11 average)

July 2012
European autos
EMEA Equity Research
2.75
Sector Avg = 4.4%

2.50 Faurecia

2.25

2.00
Asset Turnover (x)

1.75

Leoni
1.50

PSA Daimler
Valeo Volkswagen Sector Avg= 1.2x
1.25
BMW

1.00 Rheinmetall
Continental Michelin
Elringklinger

Nokian
Renault
0.75 Pirelli

0.50
0% 5% 10% 15% 20% 25%
EBIT Margin(%)
Source: Company data, HSBC

abc
 EMEA Equity Research
European autos abc
July 2012

Sector description Horst Schneider*

Analyst
The European automotive sector plays a vital role in the European economy, supporting around 12.6m jobs HSBC Trinkaus & Burkhardt
AG, Germany
(2.3m directly) and contributing significantly to the EU’s GDP, with net trade of some EUR60bn a year +49 211 910 3285
horst.schneider@hsbc.de
(source: ACEA). At 17m vehicles pa, Europe accounts for 25% of global auto production, led by Germany,
Niels Fehre*, CFA
France and Spain. Developments in the auto sector influence many other sectors (eg capital goods, steel and Analyst
chemicals) and are thus closely monitored by financial analysts as well as the political community. The sector HSBC Trinkaus & Burkhardt
AG, Germany
can be broadly divided into mass-market car makers and premium car makers. +49 211 910 3426
niels.fehre@hsbc.de
Mass-market manufacturers derive most of their sales from smaller and cheaper cars, which typically *Employed by a non-US affiliate
have lower margins and are more exposed to cyclical demand than more expensive models. These of HSBC Securities (USA) Inc,
and is not registered/ qualified
companies rely on high production to push asset turnover, which, in turn, is the key driver of profitability. pursuant to FINRA regulations
Besides being exposed to the fragmented small-car segment, they are challenged by low capacity
utilisation and constant pricing pressures, predominantly in Europe.

Premium car makers, with exposure to the larger-car and SUV segments, typically achieve higher margins.
Added value from advanced technology, rich features and brand equity enable them to command higher
transaction prices. However, they face challenges from stricter CO2 regulations globally, which oblige them to
invest heavily in developing low-emission technologies. Furthermore, greater market fragmentation and a
weakening product mix (as they enter smaller-car segments) are increasing challenges.

At the onset of the economic crisis, the highly cyclical nature of the sector caused new car sales to
collapse, particularly in the Western markets, as consumer confidence plunged. Scrappage schemes
intended to boost short-term demand during the crisis pulled demand forward, creating additional
medium-term challenges, especially for mass-market car makers, as issues of overcapacity in Europe
were left largely unaddressed. Further risks for 2012 and beyond stem from plummeting consumer
confidence due to austerity measures in Europe, uncertainty about the future of the eurozone against the
backdrop of the Greek sovereign crisis and fears of a slowdown in China.

Key themes
Low car ownership in emerging markets offsets weakness in developed markets
In our view, global light vehicle sales growth will continue to be driven by emerging markets, particularly
the BRIC economies. Low car penetration and rising disposable incomes should lead to higher organic
growth in emerging markets, even though the outlook for developed markets remains uncertain. In China,
for example, only 45 out of 1,000 people and in Russia only 243 out of 1,000 people own a car, compared
with 40% to 50% of the population in Western Europe. Sales in emerging markets are skewed towards
small cars, and most purchases are by first-time buyers. In developed markets, sales are largely dominated
by replacement demand. Although we expect unit sales to grow after 2012, we do not forecast light-
vehicle sales in Western Europe and the US to return to their pre-crisis levels of 2007 until after 2014.
Thus car makers with a higher exposure to emerging markets should enjoy higher top-line growth than
those whose operations are highly concentrated in stagnating developed markets.

Modular architectures and platform sharing

A key strategy is to increase standardisation through the greater use of modular platforms. This reduces
the number of architectures even though the average number of units per model series may decline.

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 EMEA Equity Research
European autos abc
July 2012

Standardisation helps to reduce the R&D cost per vehicle and to realise purchasing synergies through the
use of shared components. Significant cost savings can be achieved by standardising components such as
air-conditioning systems, gearboxes, engines and axles, which are not technological or brand
differentiators. Modularisation also gives large car makers, such as Volkswagen, an advantage over
smaller competitors, such as Renault and PSA, since the large companies can combine more units on a
single platform.

To reduce per-unit costs and exploit the benefits of scale, car makers now increasingly rely on alliances
and joint ventures to share platforms with other manufacturers. Other areas for exploring synergies
involve joint procurement, product development and technology sharing. Some alliances, such as Renault
and Nissan, PSA and GM or Volkswagen and Suzuki, involve equity cross-holdings. Others, such as
those between PSA and Mitsubishi or Daimler and BMW, are only strategic in nature.

Size matters: capacity utilisation and restructuring

Low capacity utilisation and insufficient scale are particular concerns for mass-market car makers, where
high production volume is the prime earnings driver. Plagued by overcapacity, the European auto industry
is in dire need of consolidation, in our view: we believe this is the only way for car makers to raise
production volumes high enough to increase asset turnover and alleviate pricing pressures. Fiat’s CEO
defines this level as more than 5.5 million cars a year and more than 1 million cars per platform.

However, the political ramifications of the impact on employment levels make meaningful consolidation
difficult to achieve in Europe in the near future. In 2008 and 2009, restructuring was mostly confined to short-
time work, only temporary plant shutdowns, the transfer of some manufacturing capacity to low-cost Eastern
European sites and the achievement of some minor structural cost savings. In contrast, US companies
underwent intensive restructuring, resulting in the Fiat-Chrysler alliance and the discontinuation of many
brands. In China, one of the most fragmented markets, the government is pushing car makers to consolidate
and has also introduced mechanisms to keep tabs on capacity expansions.

Scrappage incentives distort demand and aggravate pricing risks

Scrappage schemes in the US, Europe and China significantly boosted demand in 2009 and 2010,
particularly for small cars; mass-market car makers were the main beneficiaries. Although these
incentives helped the industry get through the crisis, they pulled forward future demand, causing declines
after they expired. Margins face additional risks as consumers have become accustomed to the incentives
and now expect discounts from car dealers, at a time of declining demand. On our estimates, net prices for
mass-market cars in Europe declined by around 1.5% on average in 2011. This increases the need for car
makers to cut costs in order to compensate for the negative pricing effects.

CO2 regulation and high R&D requirements

Regulation plays a pivotal role in shaping the industry structure and its future growth trajectory as it
encompasses rules on emissions and safety. Concerns about climate change mean that stricter CO2
emission rules are the regulatory issue most affecting the car industry. In Europe, for example, legislation
mandates a reduction in tailpipe CO2 to an average of 130g/km through technology measures. This will
apply to 65% of newly registered cars by 2012, increasing to 100% by 2015. Average CO2 emissions
already declined to 140g/km in Europe in 2011 (source: Transport & Environment, Brussels) and most

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 EMEA Equity Research
European autos abc
July 2012

European car makers should meet the regulatory target by 2015. However, CO2 emissions will also need
to be cut thereafter since the European Commission has set a target of 95g CO2/km on average per new
car in 2020. In our view, this target can only be achieved by increasing the penetration rate of hybrid and
electric vehicles, which require ongoing high R&D spending for all car makers in Europe (particularly
premium manufacturers). European car makers have spent an average of around 5% of their revenues pa
on R&D in the past five years, which corresponds to around EUR3.5-4bn per car maker. We expect R&D
expenditure to remain high in the next few years, increasing the need to allocate this burden across a high
number of unit sales in the next few years. Size also matters in this respect.

Sector drivers
Volumes and macro indicators
Volumes are the most important factor influencing EBIT margins in the auto sector and they, in turn,
depend on macroeconomic factors such as consumer confidence, unemployment, disposable income and
GDP. Sales and production forecasts for the auto sector depend on the overall outlook for consumer
spending, which itself depends on a wide range of factors, including consumer sentiment, unemployment,
GDP growth and disposable income trends. We believe consumer confidence is the best indicator of
short-term demand developments, while unemployment rates are more of a lagging indicator.

The auto sector is highly data-intensive. Some of the most closely tracked statistics are: monthly sales
numbers from ACEA for Europe, US SAAR data, and figures from other key markets such as Brazil,
China and Japan; monthly sales by car makers; incentives data in Europe and the US; residual values of
used cars; and inventory levels at dealers.

Pricing
Pricing, another closely monitored element of car makers’ margins, is influenced by a combination of
factors, including segment/product mix shifts, new product launches and general competition. For the
mass-market segment, price elasticity is fairly high, which makes it difficult to pass on price increases to
customers. For the premium car market, pricing has been better in the past few years due to soaring
demand in China, which has led to high capacity utilisation and long delivery times. It is unclear whether
this trend will remain intact, since capacity has been increased by some premium car makers and demand
growth in China has started to cool somewhat.

Product mix and new model launches

Sales mix plays a vital role in driving car maker’s earnings margins, determining, for example, whether
sales are dominated by large or small cars. Premium car makers earn higher revenue per unit by selling
larger sedans and SUVs than the mass-market car makers, which predominantly sell smaller A-, B- and
C-segment cars. Premium car makers tend to be more profitable than mass-market car makers, largely
because small cars are lower priced and typically achieve smaller earnings margins. The number of new
model launches per year is another important metric for all car makers since new models tend to achieve
better sales volumes and better pricing than older, existing models.

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 EMEA Equity Research
European autos abc
July 2012

Exogenous factors: FX, raw material prices and interest rates

Currencies: Since companies cannot always produce their cars in the same place as they sell them, all car
makers are exposed to currency risks. The earnings of Japanese car makers have been acutely burdened by a
strong yen, while European OEMs have benefited from a weaker euro due to the sovereign debt crisis.

Raw material prices: Steel is the most important input factor for car production, accounting for around
60% (or around 1 tonne) of the total car weight on average. Car makers have been affected by higher raw
material prices since 2010 due to contract repricing with steel makers. Other commodities used for car
production include aluminium, plastics, precious metals and rubber.

Interest rates: Financial services is an important tool that enables car makers to stimulate their new car
sales and keep residual values under control. At German premium car makers, an average of roughly 40-
50% of new car sales also include a lease or financing contract (source: company data for 2011). Due to
low refinancing costs and low credit loss ratios the financial services business has been highly profitable
for most car makers in the past two years. In the event of an economic downturn, declining residual
values are the main risk to earnings since cars coming off lease may be sold at a lower-than-expected
price, creating the potential for high one-off charges at car makers – as seen at BMW and Mercedes Cars
in 2008 and 2009.

Key segments
Car makers (OEMs), automotive suppliers, tyre makers
In addition to the car makers, explained in detail above, the sector includes automotive suppliers and tyre
makers further downstream. Some of these suppliers are majority owned by OEMs, which are their main
customers.

Auto suppliers’ sales are primarily driven by production volumes and are therefore cyclical in nature.
Other important drivers are geographic exposure, as well as exposure to OEMs (premium versus mass
market), fast-growing technologies (such as active safety and emission technologies) and the key growth
platforms of OEMs (such as MQB at Volkswagen). Bosch, Continental, Faurecia and Valeo (all
European), Delphi, Johnson Controls and Magna (all US), and Aisin Seiki and Delphi (all Japanese) are
some of the major auto suppliers commanding a global footprint.

Tyre makers are considered more defensive in nature than suppliers and less exposed to the vagaries of
macroeconomic conditions, since around 75% of total tyre sales typically stem from the replacement
channel. Tyre makers are segmented by type into passenger car tyres (summer and winter (highly
profitable)), truck tyres and specialty tyres (eg mining, agricultural, aircraft tyres). Key trends include: (1)
shifting the focus to profitable premium segments; (2) a focus on regions with high growth and profit
potential (LatAm and Russia); and (3) the impact of new regulations (eg EU tyre legislation from
November 2012). Tyre makers are exposed to the highly volatile prices of natural rubber (highly
speculative prices and exposed to weather conditions in South-East Asia) and oil (the source of synthetic
rubber and carbon black, among others). Michelin, Bridgestone, Goodyear and Continental are global tyre
makers operating across all segments, while niche players Nokian and Pirelli operate in highly profitable
segments/regions. Like the car makers, Michelin and Pirelli release market data for their major regions,
and this is a closely tracked statistic in the subsector.

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 EMEA Equity Research
European autos abc
July 2012

Valuation
The visibility of sector performance is good, as most companies provide detailed disclosures by business
segment on a quarterly basis; French firms are the exception, as they provide only sales and revenue data
quarterly, reporting both earnings and cash flow in their half-yearly report. Monthly unit sales figures also
give the market visibility on the sector’s top-line development.

Companies in the sector are typically assessed on traditional multiples, which are EV/sales, EV/EBITDA
and price/earnings ratios. We prefer to value most companies on a sum-of-the-parts basis, which makes it
possible to factor in valuation differences between mass-market, premium car and truck brands. We
currently tend to value the automotive business of premium car makers at EV/sales of 35% and EV/
EBITDA of 3.0x, whereas we value the automotive business of Renault and Peugeot at an EV/sales of
only 4% and an EV/EBITDA of 0.4x – roughly in line with the current valuation implied by (Factset)
consensus for 2012. Furthermore, we tend to value stakes held in other companies at their market or book
value, less a holding discount of at least 30%. We value the companies’ financial services businesses at
around 80% of their 2012e book value.

The main problem for us at present is coping with the current de-rating of the sector. On average, the
sector is trading 30-40% below the 12M-forward (Factset) consensus multiples seen in 2004-07, even
though the profitability of some companies (such as German car makers) is now higher. The market
seems not to believe that the currently high earnings of the premium car makers, in particular, are
sustainable. For European car makers, the average sector 12M-forward PE is currently around 6x (source:
Factset) versus around 10x for the period 2004-07. Although auto suppliers trade at similar multiples, tyre
makers generally enjoy a premium as their business is less volatile.

Autos: growth and profitability

2008 2009 2010 2011 2012e
Growth
Sales -0.8% -12.1% 21.5% 15.3% 7.1%
EBITDA -16.2% -29.3% 81.2% 12.2% 9.9%
EBIT -44.0% -99.4% nm 32.9% 4.9%
Net profit -29.2% -136.8% nm 52.5% -7.9%
Margins
EBITDA 11.9% 9.5% 14.2% 13.9% 14.2%
EBIT 3.2% 0.0% 6.1% 7.0% 6.9%
Net profit 3.1% -1.3% 4.8% 6.3% 5.4%
Productivity
Capex/sales 7.6% 6.8% 6.0% 6.6% 6.9%
Asset turnover (x) 1.2x 1.1x 1.2x 1.2x 1.2x
Net debt/Equity 0.1x 0.0x -0.2x -0.1x -0.1x
ROE 9.5% -3.7% 15.1% 19.3% 15.6%
Note: based on all HSBC coverage of Auto OEMs, suppliers and tyre makers across Europe.
Source: Company data, HSBC estimates

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 EMEA Equity Research
European autos abc
July 2012

Sector snapshot
Key sector stats Core industry driver: car registrations driven by consumer
confidence
MSCI Europe Auto and 3.2% of MSCI Europe
Components Index 15.0 102
Trading data
14.5 101
5-yr ADTV (EURm) 1,588
Performance since 1 Jan 2000 14.0 100
Absolute 4.05%
Relative to MSCI Europe 37.81% 13.5 99
3 largest stocks Daimler, BMW, Volkswagen 13.0 98
Correlation (5-year) with MSCI Europe 0.83
12.5 97
Source: MSCI, Thomson Reuters Datastream, HSBC
12.0 96

2007
2001
2002
2003
2004
2005
2006

2008
2009
2010
2011
2012
Top 10 stocks: MSCI Europe Auto and Components Index
Stock rank Stocks Index weight
W Europe PC registration 12M rolling (m)
EU consumer confidence indicator
1 Daimler 27.65%
2 BMW 17.61% Source: Thomson Reuters Datastream, HSBC
3 Volkswagen 19.79%
4 Michelin 7.71%
5 Renault 5.32% PE band chart: MSCI Europe Auto and Components Index
6 Porsche 5.19%
7 Continental 4.77% 300
8 Fiat 3.01% 250 15x
9 Nokian 2.81%
10 Pirelli 1.55% 200
10x
150
Source: MSIC, Thomson Reuters Datastream, HSBC
100
50 5x
Country breakdown: MSCI Europe Auto and Components Index
0
Country Weights (%)
2003

2004

2005

2006

2007

2008

2009

2010

2011

2012

Germany 75.6% MSCI Europe Auto & Comps

France 16.2%
Italy 5.6% Source: MSCI, Thomson Reuters Datastream, HSBC
UK 3.47%
Finland 2.6%
PB vs. ROE: MSCI Europe Auto and Components Index
Source: MSCI, Thomson Reuters Datastream, HSBC
2.5x 20%
15%
2.0x
10%
1.5x 5%
0%
1.0x
-5%
0.5x -10%
2009
2004

2005

2006

2007

2008

2010

2011

2012

ROE (RHS) PB ratio

Source: MSCI, Thomson Reuters Datastream, HSBC

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