Cyclical or Secular? Euro auto stocks under pressure, but credit is different

Cyclical or secular? BMW's recent profit warning - EBIT 2026 margin downgraded to 1-3% this year - highlighted that the European auto sector faces headwinds from worsening consumer sentiment and lower demand from China. Car makers in Europe have relied upon Chinese demand for exports of combustion engine vehicles, a source that is rapidly fading. The reasons are partly cyclical but also underline the secular trend permeating the industry - China is producing high-quality, low-cost vehicles that are popular in China as well as in traditional developed markets. Equity investors are mainly focused on the secular. Stock prices are down significantly - between 30-50% YTD - amid uncertainty over ability of OEMs to adjust their strategy to this long-term threat.

And credit investors? They are somewhat less perturbed. BMW's 5-year CDS spreads are trading at 51bps, just 5bps wider YTD. It's a similar story with Mercedes-Benz - closely correlated with BMW - and higher beta names VW and Renault. All of the names widened during the market sell-off in March and subsequently recovered. The exception is Stellantis, which is nearly 40bps wider and trading at 170bps. This reinforces the OEMs longstanding status as cyclical credits. VW has a positive credit beta to the iTraxx Main while BMW and Mercedes both possess betas slightly below 1. Renault and Stellantis are constituents of the iTraxx Crossover, reflecting their BBB- rating by S&P Global Ratings. Renault was upgraded earlier this year while Stellantis is on negative outlook - the trajectory and levels of their CDS spreads tell the story.

It appears the negative secular trend in autos is of secondary importance to credit investors, in stark contrast to their equity counterparts. This may seem counterintuitive but there are good reasons why this is so. For credit investors, the key challenge is not predicting whether Chinese OEMs gain market share - it is identifying which European OEMs can absorb that pressure while maintaining investment-grade balance sheets and bondholder protection. 

History gives us a useful comparison. In the 1970s, US car makers faced intense competition from Japanese producers. Significant market share was lost in that decade, but it wasn't until the 2000's that credit deteriorated materially. In the interim, protectionist policies were implemented and US producers adjusted their business strategies.

If we see a similar non-linear deterioration in Europe, then the reaction of credit spreads makes sense. The debt maturity profiles of European OEMs are significantly shorter than the circa 30 years it took for US car makers to struggle to repay debt. And ultimately that's what credit investors are concerned about - receiving coupons and principals. Hence their primary focus is on balance sheet strength, cash generation and access to capital markets. In this regard most European OEMs are in solid shape, and this is reflected in their credit spreads.

But not all bondholders are "buy-and hold" and mark-to-market risk needs to be taken into consideration. This is not a homogenous sector by any means, and the erosion of market share will impact some European OEMs more than others. Single-name CDS are highly liquid throughout the sector and may be the most appropriate instrument to express relative value positions.

European autos will remain cyclical names for credit investment time horizons and a core component of the IG universe. And their strategic importance to European economies provides implicit support and cannot be dismissed. But over the longer-term, we expect that secular trends will impact credit spreads, leaving investors to pick the winners and losers.