Clouds of gloom lift for European car stocks

European car stocks basked in a rare ray of optimism on Wednesday as the euro's slide against the dollar and sales gains in France and Spain last month helped the struggling sector advance from depressed valuation levels.

The DJ Stoxx European car sector index surpassed 203 points for the first time in seven weeks to approach three-year highs above 208.42 - paced by hefty gains at German carmakers Porsche, BMW and Volkswagen.

"The auto sector is clearly profiting from the falling euro," one Frankfurt stock trader said. The common currency hit an eight-month low against the dollar, making sales in the crucial US market more profitable.

Better-than-expected May sales figures from VW's premium unit Audi - which boosted deliveries to customers in Germany by nearly a third - also helped Volkswagen stock.

Some analysts have turned more upbeat on the car sector of late, noting the earnings drag was waning as the strong euro eased and prices for steel and raw materials came off highs.

Credit Suisse First Boston, which had been bearish on the European auto sector for months, upgraded it to market performer in mid-May, citing better-than-feared first-quarter results and strong cash generation that increasingly flows to investors.

The sector could make an additional three billion euros in operating profit if the euro fell to $1.15 within a year, CSFB said, suggesting investors focus on VW, BMW, Porsche, and DaimlerChrysler - four European carmakers that are significantly exposed to the dollar.

JP Morgan also warmed to European car stocks last month, noting historically low valuations, early signs that cyclical headwinds were abating, and the industry's cautious use of capital and willingness to return cash to shareholders.

It recommended Renault for its above-average organic growth and cost-cutting momentum; BMW for the same reasons plus its plans to start buying back shares; and DaimlerChrysler on confidence that Chrysler will cement US market volume while Mercedes mounts a gradual turnaround.

The car index has underperformed the broader European market by over seven per cent over the past year. Its components trade at a cumulative 8.8 times estimated 2006 earnings versus 12.1 times for the broader market, according to Reuters data.

But the case for buying into the sector remains mixed given persistent overcapacity that keeps weighing on prices and margins, spotty demand in major markets like Germany and the persistent inroads that Asian competitors are making in Europe.

"There is no reason to become incredibly bullish on the sector," said fund manager Pia Hellbach at Union Investment in Munich. "Porsche is the only company we can say at the moment is interesting from the story and from the valuation."

Porsche shares ended up 4.8 per cent at €592. Smith Barney analyst John Lawson said new car sales in April and May were distorted this year by early Easter holidays, which skewed comparisons.

"There has been a little bit of ducking and diving on the pricing side to make sure stalls were laid out attractively for customers," he added, although this cannot mask the fact that BMW and Audi had new cars that customers were keen to buy.

Higher sales in France and Spain in May were offset by Italy, where sales tumbled nearly 28 per cent amid a truckers strike that hit shipments to dealers. Britain was also set for a weak May, he noted.

"There is no new pressure from raw materials but obviously there is a big lag effect built into the system which still has to run through," he said.