What does a potential US-EU tariff war mean for the European auto industry?

Morgan Stanley released a research report on Monday stating that the issue of automobile tariffs between the European Union (EU) and the United States has once again become a focal point. The report analyzes that there may be an increased risk of tariffs on EU vehicle exports, with German automakers being the most affected. However, if the corporate tax rate in the U.S. is reduced, the positive impact on European automakers with manufacturing facilities in the U.S. may offset the negative effects of tariffs.

Currently, the EU imposes a 10% tariff on imported vehicles, while the U.S. levies a 2.5% tariff on vehicles made in the EU, but imposes a high tariff of 25% on light trucks and pick-up trucks. Therefore, the report suggests that European exports potentially affected by U.S. tariff adjustments are typically high-end SUVs and sedans, as these premium products may have more resilience to price increases in terms of demand elasticity.

Consequently, the report posits that if approximately 1 million European-made vehicles exported to the U.S. face higher tariffs, it could lead to a decline in investor sentiment and earnings expectations in the European automotive sector, as well as a setback in sales targets for automakers.

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Excluding ultra-luxury cars, German brands such as BMW, Audi, Mercedes-Benz, and Porsche have the highest non-domestic sales in the U.S., making suppliers to these European brands also highly sensitive to changes in tariffs. Among them, Porsche's U.S. sales are entirely produced in Europe, accounting for 25% of its group sales; in contrast, 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 increased tariffs on sales could lead to a 2%-10% decline in EBIT for major European automakers and may further exacerbate profit adjustments for OEMs.

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

In fact, German OEMs are one of the main manufacturers exporting cars from the U.S. to Europe. The report suggests that Europe may choose to reduce its 10% import tariff to alleviate potential trade tensions. As a result, the profit margins of German OEMs could be improved.

However, Morgan Stanley maintains a cautious stance on the EU automotive sector. The report states that it expects increased market competition, lower prices and product mix, and still high investment spending by 2025, and believes that the outlook for automotive industry profit margins and free cash flow is very uncertain. Although the weak performance of the European automotive sector over the past three months (about -20%) has improved the risk-reward ratio, Morgan Stanley believes that the negative profit cycle has just begun. Therefore, following significant profit warnings from Stellantis, Volkswagen, BMW, and Mercedes-Benz, Morgan Stanley remains cautious about European automotive stocks.

Potential trade frictions could have a particularly significant impact on Germany. The report states that the automotive industry holds a central position in German manufacturing and has been underperforming even before the outbreak of the pandemic. The automotive industry is the largest sector in German manufacturing in terms of production, sales, and employment, so industry dynamics have a significant impact on growth, and the proportion of trade with the U.S. is also high (half of the vehicles sold by Europe to the U.S. are made in Germany). Structural challenges brought by weak global trade and increased foreign competition have put pressure on the industry and Germany's overall growth model.

According to the report, if the export tariff to the U.S. increases by 10 percentage points, it will lead to a 1.3%-3% decrease in earnings for Mercedes-Benz and BMW (depending on the assumption of demand elasticity). Conversely, if the U.S. corporate tax rate is reduced by 6 percentage points for U.S.-produced goods, the earnings of Mercedes-Benz and BMW will increase by about 1.3%. If this assumption is further balanced, completely balancing the impact of "local to local" products and products exported to the U.S., the ratio range between the impact of corporate tax adjustments (positive impact) and tariff impacts (negative impact) is 1:1 to 1:2.If we apply this proportion to the sales of European cars in the United States, where domestically produced cars account for 11.5% and cars exported to the U.S. account for 6.2%, the research report finds that the impact of the reduction in the U.S. corporate tax rate on the overall profits of European car companies may offset or even exceed the impact of tariffs.