Outlook 2025: a lower gear for Europe’s auto industry?

The European automobile market has hit a roadblock. Once a symbol of post-war prosperity and innovation, the sector now finds itself in a state of stagnation. New light vehicle registrations are stubbornly 4 million units below pre-pandemic levels, and the anticipated recovery seems elusive.

At the heart of this slowdown, we find a complex interplay of factors. Consumers across Europe and the United States are exhibiting a notable hesitation towards battery electric vehicles. Concerns over high purchase prices, limited driving ranges, and the reliability of charging infrastructure have tempered enthusiasm for these new technologies. This reluctance is unfolding against a backdrop where new car prices have escalated by more than 30% over the past five years, outstripping the modest growth in household disposable incomes. As a result, the pricing power of constructors is fading.

The broader economic climate is also casting a long shadow over the industry. Europe is grappling with weak economic growth, and many households are struggling to cope. Instead of investing in new vehicles, people are opting to keep their existing cars on the road for longer periods. This trend is reflected in the increasing average age of vehicles across the continent.

New car registrations in the EU [left] - Average age of the EU car fleet [right]

Source: ACEA, DPAM; 2024;

Government policies are adding another layer of complexity. Subsidies and purchase incentives that once shored up the market have been scaled back. Germany, for instance, reduced its purchase premiums in December 2023. The French government also continues to reduce its support for the electric vehicle segment. It recently announced the ecological bonus will be significantly reduced for passenger cars, while the ecological bonus for light commercial vehicles will end entirely. These policy shifts are removing a crucial support mechanism for battery electric vehicles and add to industry’s mounting challenges.

In China, the situation presents its own difficulties. Demand for premium vehicles is waning, and intense competition in the lower market segments is leading to overcapacity issues. Tariff disputes are further complicating matters, creating additional hurdles for manufacturers operating on a global scale.

Automotive parts suppliers such as Forvia, Hella, ZF Friedrichshafen, Continental, and Schaeffler are feeling the pressure. Lower raw material costs might seem like a small consolation, but they are insufficient to offset rising labour expenses, research and development costs, and the increasing financial demands of launching new models. The cost pressures are squeezing margins and leaving little room for error.

In response to these pressures, companies want to take decisive action but are sometimes met with governmental resistance (like Volkswagen in Germany and Stellantis in Italy). Overcapacity is being addressed through cost-cutting measures, including workforce reductions. These moves, though necessary from a business perspective, don’t address the bigger problem. The fundamental issue of weak demand, closely tied to shaky economic growth and government incentives, remains unresolved.

For investors, it’s an uncertain landscape. Credit spreads in the sector have widened, signalling caution. The heightened volatility reflects the low visibility into the industry's future trajectory. While some companies maintain strong balance sheets with cash reserves, this financial robustness is tempered by the unpredictable market conditions.

Yet, that does not mean the whole sector is devoid of opportunities. Investors might consider focusing on quality original equipment manufacturers and suppliers with a diversified geographical footprint. Firms that cater to the replacement market could be better positioned, as the ageing vehicle fleet necessitates ongoing maintenance and parts replacement. The high-risk premiums currently associated with solid companies might offer attractive returns for those willing to carefully face the necessary risks.

For now, selection is paramount. Making informed choices about where to allocate capital could make the difference between profit and loss. It's a time for diligence and strategic thinking rather than bold, sweeping investments.