F Ford Motor Company

By Eric Sylvers 

After years of financial heartache in Europe, second-quarter results show global auto makers are finally seeing a turnaround in the region -- just as Brexit raises a cloud over the industry.

Even as they reported strong underlying second-quarter performances in Europe over the last week, Volkswagen AG, Ford Motor Co. and other auto makers flagged the potential drag created by the U.K.'s vote in June to leave the European Union.

On Thursday, VW noted Brexit's "drastic effect" on financial markets and the European economy, while Ford said the vote's outcome could cause the company to miss this year's targets even as it posted its best-ever second quarter in Europe.

General Motors Co. a week ago said the depressed pound, which is down about 12% against the dollar near to a 30-year low since the vote in the U.K., could knock $400 million off its second-half earnings. Wednesday, Fiat Chrysler Automobiles NV said hedging would protect this year's results from the sterling's fall, though should the currency's weakness last into next year the impact will be felt.

"You can run scenarios, but it's really impossible to make medium- or long-term forecasts for the car industry because there is so much uncertainty," said Paolo Martino, a senior consultant at Frost & Sullivan advising car companies.

European car makers and U.S. rivals with large European businesses have struggled for years to make money in the region. Production overcapacity, Europeans' penchant for less-profitable small vehicles, and high gasoline taxes that muted the effect of lower global prices have conspired to drag down the results for car companies in Europe.

While structural challenges remain, such as the overcapacity, auto executives had recently expressed optimism that Europe could soon begin to churn out at least modest profits.

That was until the June 23 vote in the U.K.

Now GM's target to earn money in Europe in 2016 after 17 years of losses is in doubt, as is Fiat Chrysler's bid to build on the small profit it squeezed out on the continent in 2015 after a decade of losses.

New car sales have been rising steadily in Europe over the past three years, though they are still about 10% below the pre-financial-crisis level. Registrations, a proxy for sales, rose 9.4% in the EU through the first six months of this year. But the U.K. posted a more modest 3.2% increase with a small decline in June that some analysts attributed to nervousness ahead of the vote.

Sales could be further hurt if consumer confidence takes a hit and there is a recession in the U.K., as many economists are now predicting, or if growth in the rest of the EU slows due to uncertainty surrounding Brexit.

Another blow could come if car makers raise prices to compensate for the sharp drop in the pound, which could in turn drive down sales. "Everybody is now waiting for somebody to make the first step in terms of pricing adjustment" in the U.K., Peugeot Chief Executive Carlos Tavares said on a conference call Wednesday.

On a its conference call on Thursday, VW management said business is stable in the U.K. and Brexit's only effect so far has been on exchange rates, but the company expects "dimmer economic prospects" for the U.K. and Europe as a whole.

Inchcape, which has more than 100 car dealerships in the U.K. as well as operations in about 20 other countries, said Thursday that Brexit would likely weigh on new car sales in the U.K. for the rest of the year.

Some car makers have already taken steps to confront the potential slowdown, with Peugeot, officially known as Groupe PSA SA, citing Brexit when it announced last week that it would make small production cuts at a French factory later this year.

The longer-term prospects for the European car industry will depend on how the U.K. and EU hammer out their divorce.

With the EU and the U.K. equally dependent on each other for car sales -- the U.K. exports 80% of the cars it makes with the majority going to the EU while the U.K. is the biggest market for German cars -- new trade deals between Britain and the bloc are critical to the outlook for the sector.

Auto executives hope a trade deal can be reached that doesn't include tariffs. Currently there are no tariffs on autos shipped between the U.K. and the rest of the EU. But even in a best-case scenario it will likely take several years to iron a deal.

"If a quick trade deal is reached between the U.K. and the European Union then the effects of Brexit will be minimal, but if they go toe-to-toe and the results are tariffs then everything will change," said Mr. Martino at Frost & Sullivan.

--William Boston and Christina Rogers contributed to this article.

(END) Dow Jones Newswires

July 28, 2016 12:33 ET (16:33 GMT)

Copyright (c) 2016 Dow Jones & Company, Inc.