The headlines were good this week for bulls and investors in the automotive industry, as a couple of relatively strong data points helped reenergize the sector after a largely disappointing quarterly report from Ford (NYSE: F ) just last week.
Yesterday the country's largest automotive dealership chain, AutoNation (NYSE: AN ) , soundly beat Wall Street estimates, earning $0.45 a share on a continuing operating basis compared with a forecast of $0.36 per share. Shares rose more than 11% as the earning beat is a 55% increase over its earnings last year. While CEO Mike Jackson did not want to make any detailed predictions on the coming year, he believes new vehicle sales in the U.S. will rise 11% this year, and his dealerships will outperform that number. The news sent shares of competitors like Penske Auto Group (NYSE: PAG ) and Group 1 Automotive (NYSE: GPI ) higher as well.
In addition, new car sales figures for January were released this week, and it was another strong month comparatively. Numbers released Tuesday showed the combined January U.S. sales of the top seven automakers improved 17.7% over the prior year -- led by Chrysler of all companies. All the manufacturers posted a significant improvement over the prior year, and the market is still dominated by General Motors (NYSE: GM ) , Ford, and Toyota (NYSE: TM ) , with a combined 60% market share.
While the majority of headlines this week boasted about car sales "roaring" and "racing" past last year's numbers signaling an economic recovery, I'm still skeptical how these companies will fair in the coming year. Sales still remain significantly below historical levels, and the underlying economics of the industry are still not great -- just look at Ford.
Behind the numbers
While the sales improvement is certainly a positive, investors need to be mindful of the historically low levels these comparisons are being based on. In fact, excluding last year, this past month was the worst January for car sales in the U.S. since 1983. More importantly, SAAR, the seasonally adjusted annualized rate of vehicle sales, decreased from December to about 12.6 million. This is a number that was routinely more than 16 million in the years leading up to the recession. Mike Jackson believes that it will only increase slightly too about 12.8 million this year if the recovery stays on track.
Another sign of a still-weak new car market is that the amount of manufacturers' incentive spending is creeping up again. Average per-vehicle incentive spending increased 7.5% in January from a year earlier, led by massive increases by Toyota and Honda (NYSE: HMC ) of 38% and 45%, respectively. In addition, The Wall Street Journal reported that Toyota is going to be offering consumers new finance packages with zero-interest financing as well as rebate incentives. This doesn't strike me as an exceedingly bullish indictment of the auto industry.
Other troubling signs
While automotive manufactures are clearly on the mend in terms of product quality and efficiency, the economy is still far from healthy. In addition, as Ford's recent quarterly report showed, the industry is facing rampant input price inflation. The price of steel, aluminum, and plastics are all surging, and these manufacturers have little, if any, leverage with which to raise prices.
The rising price of oil could also represent a significant hit to an already weak consumer's wallet. Jackson calls $4.50 per gallon gas prices the "freak-out number" saying, "A dramatic spike is not good for [the] economy and not good for our industry, but we're better prepared for it than we were in summer 2008."
However, any way you slice it, higher prices at the pumps will have consumers and businesses looking to downsize. This means that the higher margin sport-utility vehicles and trucks that have been boosting earnings for these manufacturers are a lot more likely to spend more time on the lot.
The automakers' stocks have been very profitable to own over the past couple of years as the industry rose from the dead, some with a little more (taxpayer) help than others. Improvements are still being made, but the comparisons will be much tougher going forward. The tailwinds that helped lift the industry from the depths have now turned into headwinds, and I think the best place to watch how it unfolds is on the sideline.