Cycles, like circles, can be vicious. Nowhere more so than in Europe's automotive industry. This is the cyclical sector most shunned by investors at present, with car makers and parts suppliers trading on an average price-earnings multiple of just over six. That is worse than miners on about nine, or construction and media, where average sector P/Es are in double digits.
There comes a point when cheap ratings turn into bargains. But some things will need to happen if Europe's auto sector is to win back favour. First, investors have to know that the cycle's low point is in sight. The number of light vehicles sold in Western Europe has dropped by a quarter since 2007, and will probably be around 13 million units this year. Back in January, there were hopes that 2012 might see the sales nadir. Now, it looks as if 2013 will be worse. The eventual upturn could be laborious, too. Pessimistic forecasts suggest that the sector will struggle to reach a 16-million-plus figure before 2020.
Add in flagging demand in Eastern Europe, and that means the region overall could sell 4.5 million fewer vehicles this year than in 2007. So production overcapacity is worsening. Local plants, which were working (on average) at 80 per cent capacity in 2011, may be down to two-thirds in 2013. True, some factory closures have been announced, as well as cuts in shift working.
Even so, spare capacity in Europe probably amounts to more than 3 million units a year. Until that is addressed, discounting to attract sales will be intense, with Volkswagen using its deeper pockets to grab market share while South Korean car makers push into the economy sector. And apart from moves by Fiat and Peugeot to position more models upmarket, solutions are thin on the ground.
Co-ordinated capacity reductions look unlikely and mergers are as difficult as ever. The cycle has yet to turn. So investors should keep the brakes on.