European auto stocks have powered ahead this year thanks to the performance of sector heavyweight DaimlerChrysler and talk of industry restructuring, but the brakes are set to come on.

The consumer-dependent sector now faces rising interest rates, high fuel prices, currency factors, and the advance of manufacturers from the Far East, while the restructuring and takeover action looks to have petered out.

With each and every day that passes, fundamentals start to matter again a bit more and I think the risk is increasing, said Michael Raab, analyst at bank Sal. Oppenheim.

New passenger car sales in the former 15-nation European Union were down 1.3 percent over the first half of the year, the ACEA European car makers association said earlier this month.

The European Central Bank started raising interest rates in December 2005. It has raised them twice already in 2007, and at least one further increase is expected by the year-end. The Bank of England has raised rates five times since August last year.

Crude prices, which over the long term feed through to pump prices, stand well above $70 dollars a barrel, in sight of last August's record $78.65. And the euro climbed to a record high above $1.38 this week, up about 4.5 percent this year.

Continued euro strength threatens to spoil the re-rating party as a 10 percent move in US$/EUR hits German auto profit by roughly 15 percent on an unhedged basis, Morgan Stanley said in a research note, even though it said it expected second quarter earnings to throw up some positive surprises.

Analysts also say the cost bases of auto firms are rising on the back of issues such as increasing environmental and safety legislation.

DaimlerChrysler's $7.4-billion sale of troubled U.S. arm Chrysler, Porsche's stake build in Volkswagen and a successful revamp at Fiat have pushed the DJ Stoxx European Auto index up 32 percent so far this year, four times the rise in the broader market.

DaimlerChrysler's own shares, which account for a third of the index, have risen nearly 40 percent.


Hopes for further restructuring action lifted the sector in May, when DaimlerChrysler sold Chrysler to private equity firm Cerberus Capital Management.

That could be it though.

The second half of the year is likely to be a lot less exciting than the first half was, said Stephen Cheetham, autos analyst at Sanford C. Bernstein.

In terms of labor cost-cutting I do believe that the window for serious restructuring has probably closed, certainly for the Germans, he said, adding that improved earnings have limited automakers' leeway for taking out more costs.

Analysts say that selling the idea of restructuring to unions has become more difficult as profitability has improved.

Those structural factors are things like overcapacity, encroaching low-cost alien competition, falling real prices ... politically-motivated cost bases, increasing regulatory burden and, to make life even worse, the Japanese and the Koreans are coming, Cheetham said.

Industry research firm Global Insight forecasts that Toyota is set to lift unit sales in Europe by 6.5 percent this year, with European sales at Korea's Kia also set to gain, intensifying competition in the sector.


Autos are trading on a multiple of nearly 16 times next year's expected earnings -- higher than their 10-year average.

At the top end of the scale, DaimlerChrysler trades on a multiple of nearly 20 times next year's earnings, compared to 13.9 times for the German blue-chip DAX index, and an increase of 40 percent over this year's multiple.

I would sell them, said Boris Boehm, head of equity portfolio management at Nordinvest in Hamburg. It would be tough to stick to the stellar performance ... The bubble is bursting.