Fitch Ratings has said that the outlook for the European auto industry in 2008 remains stable, although risks remain. All but two car manufacturers rated publicly by Fitch have a Stable Outlook (Peugeot SA and Ford Otosan AS have Negative Outlooks).

"European car manufacturers have made consistent efforts over the past couple of years to streamline their operations, improve their cost base and diversify their revenue source outside of core domestic markets," says Emmanuel Bulle, Director in Fitch's Industrials team. "Such improvements put these companies in a favourable position to cope with the difficult market conditions in Europe and the various cost pressures that continue to weigh on the industry."

As their domestic markets do not provide enticing growth prospects in the short- to medium-term, European manufacturers continue to look for growth in developing regions, particularly in central and eastern Europe (CEE), Russia, China, India and Latin America, where sales prospects are very favourable. Fitch does not expect sales in western Europe to grow by more than 1%, at best, in 2008, unless a rebound in sales in Germany finally materialises after a dismal 2007. On the other hand, Fitch forecasts robust growth rates in CEE, Russia, China and India in 2008 following an already very strong 2007. Production is also following the same route, as manufacturers deploy capacity in emerging countries to benefit from a cheaper labour force and local sourcing at a lower cost. In addition, matching the production base with end markets helps to reduce logistics costs.

Although it remains thin, the overall profitability of European auto manufacturers has improved in 2007 and Fitch expects further positive developments in 2008, although to a much lesser extent. Continuous attention to cost structure should mitigate the impact of expensive raw materials and price pressure from the severe competitive environment. The announcement made by several manufacturers after their H107 results that they would likely post better-than-expected figures in FY07 is a testament to manufacturers' confidence that they can adequately weather some of the challenges. Fitch is confident that such optimistic announcements will indeed materialise. The overall liquidity of the sector in Europe has also consistently improved, thanks to higher earnings and stronger cash generation, and it should remain resilient in 2008.

However, Fitch cautions that the improving results posted by some groups has started to generate pressure from shareholders through increased dividends, accelerated share buyback programmes and/or higher balance sheet leverage. In addition, competitive pressure remains severe in western Europe as the market is mature and heavy incentives are permanent to support sales. The risk of a faltering US economy spreading to Europe , as well as a few European countries' economies slowing down or weakening due to specific issues like a falling housing market, could threaten auto sales whilst unpredictable oil price developments may ultimately dampen customers' driving patterns and buying decisions. Lasting high oil prices will accelerate the development of more fuel efficient powertrains and consumers' choice for smaller vehicles.

Nonetheless, these challenges affect manufacturers in different ways and to different extents. Continually stricter environmental rules will represent a major burden for the whole industry, but they will predominantly weigh on German manufacturers selling premium and heavy vehicles with powerful engines. Daimler AG (Daimler, 'A-' (A minus)/'F2'/Outlook Stable), BMW Group (BMW, not rated) and Volkswagen Group's (Volkswagen, 'A-' (A minus)/'F2'/Outlook Stable) Audi are likely to be impacted the most. The average CO2 emissions from German manufacturers amounted to 173g/km in 2006, materially above the 144g/km average from the combined French and Italian groups. Fitch believes that CO2 issues are a long-term problem for the auto industry as stricter environmental regulations entail rising R&D expenditures to reduce CO2 emissions and air pollutants. The German association of the automotive industry (VDA) estimated that the cost of cutting CO2 emissions to 120g/km by 2012 would amount to approximately EUR3,000 per vehicle, on top of the EUR2,000 of extra costs already spent since 2005 on the back of various EU safety and environmental regulations.

Similarly, although unfavourable currency movements impact all manufacturers, large exporters and/or automotive companies with US operations like BMW, Volkswagen, Daimler and Fiat SpA's ('BBB-' (BBB minus)/'F3'/Outlook Stable) CNH are negatively affected by a weak US dollar. Some of these groups have already announced they are going to expand capacity in North America, while others are considering moving some of their production there. Although Renault ('BBB+'/Outlook Stable) is absent from the US market, it is nonetheless indirectly exposed to USD variations through its large stake in Nissan.