Can defense save Europe’s ailing car industry?

The European car industry is in a structural crisis. Slowing demand for electric vehicles, lost market share to Chinese competitors and higher borrowing costs have created the perfect storm for the sector over the past five years, as sales volumes continue to slump well below pre-pandemic levels. 

Europe’s automakers have a long history of producing defense equipment and weapons when called upon during wartime. Some firms now think returning to these roots could offer a lifeline.

Analysts at Citi have dubbed this shift the “anything but autos” trade.

On Monday, Renault announced it was developing a ground-based drone for military and civilian use. This followed its announcement of a partnership with defense group Turgis Gaillard in January to produce aerial drones in France. 

Meanwhile, German automaker Volkswagen is reportedly in talks with Israeli defense firm Rafael to produce parts for missile defense systems.

The pair are in discussions to convert VW’s factory in Osnabrück, Germany, into facilities for making components for the Israeli Iron Dome missile-defense system produced by Rafael, the FT reported on March 24. 

European autos are struggling to compete directly with Chinese rivals, such as BYD. While new-car sales dropped in the EU through January, BYD stunned the market by reporting a 175% year-on-year increase in deliveries to 13,982 units, according to ACEA data.

The industry’s decline is felt in carmakers’ share prices, too. The Stoxx 600 Automobiles index has fallen 30% over the past five years as of April 2, while VW has tanked over 60% since then. Stellantis, which owns brands including Fiat and Peugeot, has shed 58% over the same period.

By contrast, the European defense industry is booming. The urgent need to rearm following Russia’s invasion of Ukraine in 2022 and an apparent fracturing of relations within NATO mean Europe must become more self-sufficient in its defense production. 

Last year, EU president Ursula von der Leyen said Europe was in an “era of rearmament” and could mobilize 800 billion euros in defense investment through loans and other programs.

“The defense industry has huge growth prospects with government budgets and Nato requirements backing it,” Rico Luman, senior sector economist for transport and logistics at Dutch bank ING, told CNBC by email. 

“For the defense industry it’s rather a question of how to expand production than if. Redirecting production capacity is an opportunity for the automotive industry.”

But other analysts question whether riding the coattails of the defense sector will be enough to save the ailing auto industry, flagging several concerns about carmakers’ ability to grow in this space.