The auto sector continues to face several structural challenges as we witness a shift away from traditional combustion engines (diesel & gasoline) to electric vehicles, which is likely to boost capex. But buoyant consumer confidence amid falling unemployment in the advanced economies, even in Europe, strong growth in emerging markets, and low valuations should continue to provide sector support.

Our top picks in the auto sector are as follows:

BMW (CC Price Target €94.00)

BMW boosted profitability at its automotive operations, strengthened by record sales of models like the 5-Series sedan, to offset the negative impacts of currency headwinds and increased technology spending. Longer term we believe the market still significantly underestimates BMW’s advances in electrification and in particular the benefits of its modular production strategy.

Near term BMW is set to enjoy favorable earnings dynamics from new product momentum in the high growth, high margin SUV segment. BMW's product momentum and better understanding of its future-proofed technology strategy along with strong free cash flow and a dividend yield of above 4% should support the shares.

Valeo (CC Price Target €61.50)

We believe that Valeo is present in the fastest-growing segments in the auto industry, allowing it to reap the benefit of rapidly increasing volumes over the coming years. 1H18 should mark the trough for earnings and we expect a strong pick-up thereafter.

We remain Overweight and are confident of the execution of the solid order book.

Renault (CC Price Target €100.00)

All in all Renault reported a good quarter with some headwinds like currency and other revenue line mainly hit by accounting changes, weak product and geo mix. The key focus of investors is the current Renault Nissan merger. We expect this to reach new highs with the recent addition of Mitsubishi and Avtovaz. Renault also runs the strongest Fin Co of the industry that has limited exposure to worrying markets (US and UK). Shorter term, we expect EM to drive earnings dynamic.

Volkswagen (CC Price Target €176.00)

In the mid-term we see VW at the forefront of the industry’s move to electrification. Near-term earnings are likely to benefit from new product momentum and structural synergies. Although some unknown costs remain from Dieselgate, we see the opportunity for a rerating as the company’s multiples move closer to peers.

Conclusion

We remain confident in a diversified selection of European car and tire manufacturers and suppliers with a strong commitment to R&D-driven technology. Corporate restructurings, the future of diesel, and companies’ positioning in a disruptive automotive world will drive the sector and individual stocks.

Disclaimer:  This article was issued by Kristian Camenzuli, Investment Manager at Calamatta Cuschieri. For more information visit, www.cc.com.mt. The information, view and opinions provided in this article is being provided solely for educational and informational purposes and should not be construed as investment advice, advice concerning particular investments or investment decisions, or tax or legal advice.