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European tire makers struggle to find traction

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Surfers chase the perfect wave. Less happily, Europe's auto sector is chasing a trough. Hopes that the collapse in demand for new vehicles would bottom out in 2012 have been repeatedly deferred – first to 2013, and now, after grim sales figures for January and February, to the final quarter of this year. Morgan Stanley, for example, thinks that the bottom could be reached in the autumn, paving the way for a slow recovery by 2014-15. That would imply a further 6-per-cent fall in demand for passenger cars in Western Europe in 2013, to around 11 million units. Pre-crisis, annual totals ran at 14 to 15 million.

Inevitably, such debilitating uncertainty has implications well beyond car makers themselves. In the parts segment, tire companies are traditionally resilient thanks to more stable replacement markets. Over the past two years, shares in Pirelli, Continental and Michelin have comfortably outperformed the European auto sector overall – the first two, by four to five times. But downgrades have become prevalent even here.

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Pirelli – which draws one-third of its €6-billion ($8-billion) annual sales from Europe – guided to at least 4-per-cent growth in earnings before interest and tax in 2013 as it closed the tire makers' earnings season this week. But management's estimate is struck after an anticipated €245-million increase in costs and depreciation, only partly offset by €70-million of efficiency gains and a €55-million benefit from lower raw material prices. It also assumes flat overall pricing, while many forecasts are for tire price falls in Europe in 2013. Pirelli shares dipped on the news and are down 12 per cent from 2013 highs.

Valuations are finely balanced. Continental and Pirelli are on consensus 2013 earnings multiples of nine, falling to around eight times for 2014. That is reasonable if the European market finally makes a U-turn later this year. Warier investors, though, may prefer to avoid the mush.

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