What does the potential tariff war between the US and Europe mean for the European automotive industry?

Morgan Stanley released a research report on Monday, stating that as the US presidential election approaches, the issue of auto tariffs between the EU and the US has once again become a focus of attention. The report analyzes that if a Republican president takes office, there may be an increased risk of tariffs on EU vehicle exports, with German car manufacturers being the most affected. However, if the US corporate tax rate is lowered, the positive impact on European car manufacturers with factories in the US may offset the negative impact of tariffs.

Currently, the EU imposes a 10% tariff on imported cars, while the US imposes a 2.5% tariff on vehicles manufactured in the EU, but a high tariff of 25% on light trucks and pickups. Therefore, the report believes that European exports that may be affected by US tariff adjustments are usually high-end SUVs and sedans, as the demand elasticity for price increases of these high-end products may be more resilient.

During the previous term of former US President Trump, frequent trade frictions between the US and Europe led to the underperformance of the European auto sector compared to the Stoxx 50 index. Therefore, the report suggests that if approximately 1 million European-manufactured vehicles exported to the US face higher tariffs, it may lead to a decrease in investor sentiment and profit expectations in the European auto sector, as well as setbacks in car manufacturers' sales targets.

Apart from ultra-high-end luxury cars, German brands such as BMW, Audi, Mercedes-Benz, and Porsche have the highest sales in the US among non-domestic brands, so suppliers of these European brands may also be very sensitive to tariff changes. Among them, Porsche's US sales are all produced in Europe, accounting for 25% of its group sales; in comparison, BMW and Mercedes-Benz account for 8%, Volkswagen for 3% (indirectly affected through Porsche), Stellantis for 1%, and Renault for 0%.

The report estimates that the impact of tariff increases on sales may lead to a 2%-10% decline in EBIT for major European car manufacturers, and may further exacerbate OEM profit adjustments.

The report states that European manufacturers can avoid tariffs by increasing production in the US, but this is difficult to achieve. According to the report's analysis model, assuming the current US corporate tax rate of 21% is reduced to 15%-20%, although some EU OEMs have partially localized production in the US, Morgan Stanley believes that increasing the localization of high-end sedans is neither easy nor quick or cheap. The report estimates that if production is localized in the US, Stellantis will benefit the most, followed by BMW and Mercedes-Benz, but the impact on earnings per share (EPS) is relatively small, around 1.5%-2.5%.

In fact, German OEMs are among the major manufacturers exporting cars from the US to Europe. The report suggests that Europe may choose to reduce its 10% import tariff to alleviate the potential re-emergence of trade tensions. Therefore, the profit margins of German OEMs may improve as a result However, Morgan Stanley still maintains a cautious attitude towards the European automotive sector. The research report indicates that by 2025, market competition will intensify, prices and product portfolios will decline, and investment spending will remain high. The report believes that the prospects for industry profit margins and free cash flow are very uncertain. Despite the recent weak performance of the European automotive sector (down by about -20% in the past three months), which has improved the risk-return profile, Morgan Stanley believes that the negative profit cycle is just beginning. Therefore, following significant profit warnings from Stellantis, Volkswagen, BMW, and Mercedes-Benz, Morgan Stanley remains cautious on European automotive stocks.

The potential impact of trade frictions is particularly significant for Germany. The report states that the automotive industry holds a core position in German manufacturing and had been showing weakness even before the outbreak of the pandemic. The automotive industry is the largest sector in German manufacturing in terms of production, sales, and employment, making industry dynamics crucial for growth. Moreover, the industry has a high proportion of trade with the United States (half of the vehicles sold by Europe to the US are produced in Germany). The structural challenges brought about by global trade weakness and intensified foreign competition are putting pressure on this industry and Germany's overall growth model.

According to the report, a 10-percentage-point increase in export tariffs to the US would lead to a 1.3%-3% decline in earnings for Mercedes-Benz and BMW (depending on demand elasticity assumptions). Conversely, if the US corporate tax rate is reduced by 6 percentage points for domestically produced goods, earnings for Mercedes-Benz and BMW would increase by around 1.3%. Balancing this assumption further, the ratio range between the impact of corporate tax adjustments (positive impact) and tariff effects (negative impact) is between 1:1 and 1:2.

Applying this ratio to the sales of European cars in the US, where domestically produced cars account for 11.5% and cars exported to the US account for 6.2%, the report finds that the impact of a reduction in the US corporate tax rate on the overall earnings of European car companies may offset or even exceed the impact of tariffs.