Western European car market Light at the end of the tunnel

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1 Research Briefing Sector research January 9, 13 Author Eric Heymann Editor Antje Stobbe Deutsche Bank AG DB Research Frankfurt am Main Germany Fax: DB Research Management Ralf Hoffmann Bernhard Speyer Western European car market Light at the end of the tunnel New car registrations in the EU-15 were down for the third straight year in 1, and for the fourth time in five years. At about minus 8%, the decline was much sharper in 1 than in the previous two years. All in all, the sluggishness in Western European car sales is not just a 1 phenomenon; it has persisted for quite a long time. The macroeconomic environment in the EU-15 is set to improve only marginally in 13. Italy and Spain in particular are going to see a renewed contraction in real GDP, even though we do forecast a relative improvement for Italy. Unemployment remains high in both these countries, and Spanish households in particular are grappling with heavy debt loads. Demand for cars is influenced not only by the macroeconomic environment, but also by industry-specific factors. One positive note is that many European car makers have a well-filled product pipeline, especially in the small and compact segments. Furthermore, as competition is fierce it is common for dealers to offer buyers substantial discounts, and the persistently low interest rate environment provides favourable financing conditions. So it is still a buyer's market in Europe. In some countries a significant degree of replacement demand has accumulated. As an example, new car registrations undershot the average for the period from to 1 by 35% in Italy in 1, and by % in Spain. Given the unfavourable macroeconomic environment, though, this pent-up need for replacements is no guarantee of car demand starting to pick up again in these two countries as early as 13. Nonetheless, it is an indication at least that the markets are not going to contract more strongly than in the past few years. On balance, new car registrations will probably decline again in the EU-15 in 13, albeit at a much slower pace than in 1 (roughly -3%). The downtrend is likely to peter out already in the course of 13. In 1, new car registrations could potentially increase by roughly 5%. So there would appear to be light at the end of the tunnel in the Western European car market. Unit car production plummeted in the EU in 1 (-7%) after two years of growth. Thus, production undershot the 7 pre-crisis level by approximately 15%. There is every likelihood of a further, albeit less pronounced, decline in 13. Car makers have in the meantime started to take swingeing measures to redress the problem of excess capacities currently amounting to at least 3% in the EU. Over the past few months several companies have announced plans to shutter some of their European plants.

2 A look back: Sluggish car sales not just a 1 phenomenon EU car market: Light gradually appearing at the end of a long tunnel 1 New car registrations in the EU-15 (million) Sources: ACEA, DB Research Germany the biggest European market by far New car registrations (million) Sources: ACEA, DB Research Only Korean marques on the plus side 3 New car registrations in the EU by brand*, Jan-Nov 1, % yoy IT FR US JP KR * All brands of the respective car maker, differentiating by country of origin Sources: ACEA, DB Research New car registrations in the EU-15 were down for the third straight year in 1, and for the fourth time in five years. Only in 9, at the height of the government incentive programmes in Western Europe, did unit sales increase (by 1.1%). The decline in 1, at about minus 8%, was much more pronounced than in the previous two years (1: -5.6%; 11: -1.7%). All in all, the sluggishness in Western European car sales is not just a 1 phenomenon, though; it has persisted for quite a long time. In 1, new car registrations were roughly 1% short of the 7 reading, falling to their lowest level since The reasons for the weakness of car demand are mainly linked with the ongoing economic crisis in much of Western Europe. Among the five biggest EU member states, which account for 8% of all new car registrations in the EU-15, it is only logical that Spain and Italy posted the steepest declines in recent years. After all, these are the countries where the macroeconomic environment (scope and duration of the recession, unemployment, household debt) has been the most severe. The downtrend continued in both countries in 1: new car registrations fell by around 13% in Spain and by % or so in Italy. Unit sales shrank by about 1% in France in 1, whereas they had held steady at a fairly high level there in the three prior years. At present, the car markets in Germany and the United Kingdom are proving relatively stable. Germany posted a 3% decrease in new car registrations in 1, whereas the achieved an increase of roughly 5% no less. Car purchases brought forward by economic stimulus programmes are still being felt Compounding the current weakness of car sales is the fact that the government incentive programmes of 9/1 resulted in consumers bringing forward car purchases. Demand for cars in Germany really spiked in 9 on account of the extensive scrappage bonus made available for that particular year (and retraced accordingly in 1). The high levels in France (particularly in 9 and 1) mentioned above can be explained by such stimulus programmes. Since government subsidies mainly stimulated sales of small and compact cars it comes as little surprise that in 1 not only the French and Italian marques, but also those of Japanese producers and of the European subsidiaries of US makers in the EU-15 recorded much poorer sales than German makers with their focus on higher-quality vehicles. Korean marques actually confounded the trend in 1, posting noticeable gains. They currently score well with customers in terms of value for money and are wresting market shares from other makers in the volume segment. The French and Italian car makers are being hit in any case by the fact that the economically ailing Southern European markets are generally of greater significance to them than to say the German or Asian suppliers, which on average are better positioned in the growth markets outside of Europe. On balance, the sales slump in the Western European car market has taken a very wide variety of forms both in regional terms and at the company level. Outlook: 13 still a struggle, improvement from 1 The macroeconomic environment in the EU-15 is set to improve only marginally in 13. Real GDP is going to contract again in Italy and Spain in 13, even though we expect a relative improvement for Italy. Unemployment remains high in both these countries, and Spanish households in particular are grappling with heavy debt loads. We believe French GDP will marginally decline in 13, which January 9, 13 Research Briefing

3 EU is chief export destination EU share in car exports of individual countries, 11 or most recent data (%) ES IT Sources: SMMT, VDA No broad-based upswing until 1 5 Real GDP growth (% yoy) Sources: National authorities, DB Research Unemployment remains high in Southern Europe 6 Unemployment rate* (%) * ILO definition Sources: National authorities, DB Research would be a slight deterioration vis-à-vis 1. Our call on German GDP is for expansion again in 13, but at a much slower pace than in 1. Among the major EU economies the is putting in the best performance with projected GDP growth of 1% in real terms. In 1, GDP is expected to pick up again in all the countries examined here, and thus in the EU-15 as a whole. However, unemployment rates are expected to remain high in the countries of Southern Europe, weighing on private consumption and thus curbing car sales. Corporate investment activity is not likely to recover in all countries until 1, though at an only moderate pace. This suggests that the car-buying stimuli from the commercial sector are likely to remain limited for a while. Again, this applies mainly to Southern Europe. The economic growth forecast for Western Europe is fraught with considerable uncertainty. The chief risk factor is the ongoing euro crisis, which we expect to start easing in the course of 13. The forecasts for 1 are additionally affected by uncertainties in connection with the longer time horizon. Replacement needs likely to feed through gradually to market demand Car sales are influenced not only by the macroeconomic environment, but also by industry-specific factors. On the supply side, one positive note is that many European car makers have a well-filled product pipeline, especially in the small and compact segments. Furthermore, as competition is fierce it is common for dealers to offer buyers substantial discounts, and the persistently low interest rate environment provides favourable financing conditions. So it is still a buyer's market in Europe. For the development of unit car sales in 13/1, however, the factors on the demand side are likely to be of greater importance. As already mentioned above, the macroeconomic environment is set to remain difficult on the demand side in 13, although it should start to improve in 1. In largely saturated markets such as Western Europe, however, the demand for cars is driven to a significant degree by replacement needs. And in this respect a considerable amount of demand potential is accumulating in several Western European markets despite the impact of the 9/1 government incentive programmes discussed earlier. This is because the sales figures achieved over the past few years and also in 1 now fall far short of the long-term averages in many countries. New car registrations in the EU-15 for 1 were no less than 16% shy of the average for the years to 1. In a few EU countries, though, the situation is much more dramatic: in Italy, for instance, new car registrations undershot the long-term average ( to 1) by 35%, and the highest reading during this period by no less than %. In Spain, the comparable underperformance is even more pronounced at % (versus the average of the period) and 57% (versus the peak). These figures already point to a certain degree of replacement need which in some cases can no longer be postponed, because many vehicles (those requiring frequent repairs) cannot be used any more for technological reasons or because it no longer makes economic sense to do so. According to the European Automobile Manufacturers' Association (ACEA), in 1 (latest figures available) close to 36% of all cars in the EU were more than ten years old. The need for replacement is being exacerbated in Italy and Spain in particular by the fact that the sales slump has persisted for several years and the trend was scarcely interrupted by the purchase incentive programmes. This trend can be statistically underpinned by analysing the ratio of new car registrations in a given year to the respective total number of cars over time. For the five biggest EU countries and the years to 7 this ratio was 7.%, i.e. on average 3 January 9, 13 Research Briefing

4 Car markets contracted sharply particularly in Spain and Italy 7 New car registrations, = EU-15 Sources: ACEA, VDA, DB Research Replacement demand building 8 Ratio of new car registrations to total number of cars (%) * * In 7, car market statistics in Germany were rebased Sources: ACEA, VDA, DB Research Scraping the bottom? 9 New car registrations in 1 compared to past lows FR EU-15 IT ES Difference (%) to -1 average Difference (%) to maximum reading from to 1 and in notional terms over 7% of the cars on the road were replaced or newly registered every year. Starting with the crisis at the end of 8 this ratio fell in Italy and Spain at a nearly steady pace, and for 1 Italy probably achieved a reading of 3.7% and Spain in fact only 3.1%; in Spain the share of new car registrations in relation to the total number of cars on the road averaged just over % between 8 and 1. Especially given the unfavourable macroeconomic environment, though, the low readings offer no guarantee of car demand starting to pick up again in these two countries as early as 13. Nonetheless, it is an indication at least that the markets are not going to contract more strongly than in the past few years. For 1 at the latest we believe Italy and Spain are likely to start posting increases in new car registrations. Further downside potential in France better prospects in the and Germany The situation looks different in France. Here, for example, new car registrations for 1 were down "only" 1% on the average for to 1. From 9 up to the end of 11, however, they far outstripped the long-term average, which was partly attributable to the economic stimulus programmes during this period. So the effects of purchases being brought forward played a much more important part in France than in Italy or Spain. In this respect, 13 certainly does still harbour considerable downside potential, especially since the general economic conditions in France remain difficult. Therefore, we also expect the French market to see a further decline in new car registrations in 13. In 1 demand will probably at least stabilise. In the United Kingdom, new car registrations fell short of the long-term average by 11% in 1 and thus roughly matched the performance in France. However, sales levels in the three prior years had been much lower than in France. And since the general economic conditions in the will probably continue to improve in 13, new car registrations could in fact increase again in a best-case scenario. As things stand today, 1 might see car sales move sideways. In relative terms, Germany chalked up the best performance of the major EU-15 economies in 1 in a long-range comparison: new car registrations were "only" 6% shy of the long-term average. In this context it ought to be noted that since 1991 new car registrations in Germany have only twice(!) been lower than in 1, that is in 8 at the outset of the crisis and in 1 in response to the end of the scrappage bonus. According to our current forecast, private consumption is set to provide moderate stimuli to overall growth in 13 (real +.6% as in 1). By contrast, investment in machinery and equipment is poised to decline by about 1% again, albeit much less sharply than in 1 (-5%). In this environment there is unlikely to be a tangible uptick in new car registrations. Instead, we expect them to be more or less flat. In fact, the German Association of the Automotive Industry (VDA) is even more pessimistic and projects a further decline in domestic sales, although it does point to the many risks currently compromising forecast reliability. For 1 we expect Germany to turn the corner and post a noticeable increase in new car registrations. On balance, new car registrations will probably decline again in the EU-15 in 13, albeit at a much slower pace than in 1 (about -3% as opposed to -8%). In this scenario, the downtrend is likely to end in the course of 13. In 1, new car registrations could potentially increase by roughly 5%. So there would appear to be light at the end of the tunnel in the Western European car market. Sources: ACEA, VDA, DB Research January 9, 13 Research Briefing

5 Comparison with US car market supports hopes of impending upswing US car market has left the through, EU-15 still poised for upswing 1 New car registrations (EU-15) and light vehicle sales (US), (million) EU-15 Sources: ACEA, Bureau of Economic Analysis, DB Research US A comparison of the Western European car market with that of the United States nurtures hopes that car demand in the EU-15 could soon increase. Between 6 and 9 unit sales of light vehicles (LVs) in the US slumped by a total of 39%, with the declines in 8/9 being particularly pronounced. Before 6 sales had been relatively high. Thus the decline in LV sales in the US during the crisis years had been nearly twice as high as hitherto in the EU-15, where unit car sales compared to the US started to fall with a time lag of two years. Since 1 there has been an impressive turnaround in the US car market. In 1, LV unit sales grew at a double-digit rate for the third year in a row. This recovery was partly driven by the US government's fiscal and monetary stimuli. However, it can now be said that the US car market is back on its own two feet. We therefore expect US sales of LVs to rise again in 13. And on a longer-term horizon, too, the US car market appears to be on track for growth, a prospect suggested by US demographics alone (5 million more inhabitants by 3). All in all, the shrinking process in the EU-15 is set to persist longer than in the US, but the overall decline should be less steep. At the same time, the upswing anticipated in the EU-15 will be less dynamic than overseas, which is why it will probably take longer to return to the high pre-crisis level. The long-term prospects for the Western European car market are much more subdued than for the US because of the negative demographic trend in Europe. EU car production declining capacity reductions inevitable Car production down in 1 11 EU passenger car production (million) Source: ACEA Finally, we want to take a look at car production in the EU. After two years of growth, unit production started to fall again in the EU in 1 (-7%), undershooting the pre-crisis reading from 7 by around 15%. There is every likelihood of a further, albeit less pronounced, decline in 13. Some car makers are now reacting to the problem of excess capacities that has been endemic in the sector for a number of years: recently, several companies have announced plans to shutter car plants in Europe. There are several major reasons for the excess capacities that currently amount to at least 3% in the EU. These are a natural consequence of productivity gains in the factories. Also, there is considerable competition from Asian suppliers as the EU is a relatively open market. Furthermore, following the fall of the Iron Curtain and the EU's eastern enlargement, manufacturers built up capacities in Eastern Europe. However, many of the factories are geared to the more or less stagnating European market. If this market becomes mired in a long-lasting sales slump, such as recently, companies will have virtually no choice but to adapt their capacities accordingly. The objective of such measures is to boost utilisation rates and thus productivity in the remaining factories. Timelier moves to reduce capacities the approach taken in the US were thwarted by the various economic stimulus programmes and the, in some cases, close political and capital ties between the industry and the government. The closure of a major plant is invariably a sensitive political issue because it affects many people in one place. However, the plant closures announced must not be interpreted as the first nail in the coffin for Europe as a car manufacturing location. After all, just recently several companies (also non-european ones) have said they intend to boost investment in their existing factories. Of course, though, the competition between the car production sites scattered around the globe is not going to lose any of its intensity in future. Eric Heymann ( , eric.heymann@db.com) 5 January 9, 13 Research Briefing

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