Stock Market Comment: German carmakers surprise with solid earnings

• DAX earnings season is almost over

• German companies outperformed US peers in terms of growth

• Margins of carmakers improved over the past year

• Car parts manufacturers expect sector to struggle until second half of 2020

• DE30 started trading sideways after failed attempt of breaking above 13330 pts

Earnings season for the German DAX index is nearing an end. In this commentary we will take a quick glance at how DAX members coped in Q3 2019 and pay more attention to the automotive companies.

In spite of macroeconomic gloom, DAX companies report higher earnings

Speaking of Germany, the first thing that comes to mind is a plunge in survey gauges and overall deterioration in hard data. Having said that, one may find surprising that German blue-chips managed to report results that were, on average, higher than a year ago. Sales growth of over 6% YoY is almost twice as high as the one for the S&P 500 index. Moreover, double-digit earnings growth of the DAX index looks stellar compared to 1% decline in earnings for the US index. In spite of their perceived high correlation with the economy, automotive companies turned out to be one of the best performing sectors in the third quarter of 2019.

DAX earnings season for Q3 2019 is almost over. The German blue-chips performed much better than their US counterparts in the July-September period. Surprisingly, carmakers turned out to be one of the best performing companies. Source: Bloomberg

Cost discipline and one-offs help carmakers report earnings growth

Stocks of the German carmakers await a decision from the United States on whether to impose car tariffs or grant another extension. As the latter option is expected, sentiment towards the automotive sector remains upbeat.  However, valuations of the sector are also being boosted by solid earnings reported for Q3 2019. Production of passenger cars in Germany was 0.59% YoY lower in Q3 2019 but given how macroeconomic situation has deteriorated over the past year, such a small drop shows resilience of the sector. In fact, Volkswagen was the only German carmaker to report lower car sales in Q3 2019. Combined revenue of three German carmakers increased 9.3% YoY in Q3 while net income was over 20% higher than a year ago. Given that production was almost unchanged year-over-year, one may wonder how companies managed to improve sales and earnings so much. The answer is simple: cost cuts and abnormal items. A bulk of Daimler’s earnings increase can be ascribed to disposal of assets, Volkswagen lowered operating expenses and booked smaller abnormal loss while BMW managed to lower its cost of revenue and operating expenses. 

Combined performance of the German carmakers improved significantly from a year ago. Margins were higher all across the board while operating cash flow was positive. Higher capital expenditures are promising. Data on the left chart is in EUR millions. Source: Bloomberg, XTB Research

Solid demand from China, Germany and Japan in Q3 2019

Taking a look at the combined sales of Daimler, Volkswagen and BMW, one can see that total worldwide sales declined 1.6% YoY in the third quarter. However, detailed breakdown may be surprising to some. Economic slowdown in China is a major theme on the markets now but vehicle sales data from German carmakers contrasts this view - sales in China were slightly (0.7%) higher in the July-September period. The biggest decline in percentage terms was spotted in Europe. However, details here are surprising as well - in spite of terrible data from the German economy, Germany was the only major economy to experience double-digit pace of sales growth. Speaking of major economies, solid sales growth was also spotted in Japan (9~ % YoY). However, in this case it can be ascribed to front-loading ahead of sales tax increase.

Worldwide sales of German carmakers were lower than in Q3 2018. Increase in China looks somewhat surprising. However, BMW was responsible for a major part of this increase as SUVs are gaining popularity in the World’s second largest economy. Data in thousands of units. Source: Bloomberg, XTB Research

Car parts manufacturers expect weak quarters ahead

The situation does not look as bright when we take a look at reports of car parts manufacturers. In spite of an expected EPS of €2.053, Continental reported a massive loss of €9.93 per share. A bulk of this loss came from an impairment charge of €2.5 billion as the company now expects slower growth of automobile production. Infineon Technologies managed to improve revenue but saw a significant margin contraction in its automotive segment in Q3 2019. The German semiconductor company explained that weak global auto demand caused its production facilities to be underutilized and that it did not expect improvement ahead of the second half of 2020. While Osram Licht  is not a DAX member, it is worth to mention it as it also has significant exposure to the automotive sector. The German lightning manufacturer swung to a full-year loss for fiscal 2019 (ended September 30) after reporting quarterly earnings and warned that it does not expect automobile production to pick-up in the near future. However, it is nothing new as Osram’s automotive segment has been contracting for at least a year.

Detailed segment revenue data from Continental, Osram and Infineon is limited and isolated automotive-related revenue figures are available for just 8 quarters. The picture does not look to grim as sales were at the highest on record. However, car parts manufacturers complained about margin squeeze. Source: Bloomberg, XTB Research

The key takeaway is that while Q3 2019 was a good quarter for the German automotive sector, a longer-lasting improvement seems questionable. Carmakers increased earnings on the back of one-offs and cost cuts and those may not recur in the quarters ahead. Car parts manufacturers expect automotive sector to struggle until at least second half of 2020. On the other hand, increased capital expenditures can be seen as a positive but they risk creating a supply glut in case demand fails to pick-up. Last but not least, while the automotive sector is important for the German economy, its significance for the DAX index is not that great - 3 carmakers and Continental account for less than 11% of index’ weight together.

DE30 halted upward move slightly below the 13330 pts handle. The index began to trade in 13160-13330 pts range afterwards. The lower limit is tested at press time but a trigger could be need for a break lower. The index made a massive 2380 pts increase in the first half of the year. Should the ongoing upward impulse be equal, the index could rally towards the 13625-13630 pts area - and that would mean fresh ATH. Source: xStation5