Auto Recovery Faces Significant Headwinds

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.

Andrew Bond owns no shares in the companies listed. Ford Motor is a Motley Fool Stock Advisor choice. General Motors is a Motley Fool Inside Value pick. You can follow Andrew on Twitter @Bond0 or on his RSS feed. Try any of our Foolish newsletters today, free for 30 days. The Fool has a disclosure policy.


Read/Post Comments (10) | Recommend This Article (7)

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Help us keep this a respectfully Foolish area! This is a place for our readers to discuss, debate, and learn more about the Foolish investing topic you read about above. Help us keep it clean and safe. If you believe a comment is abusive or otherwise violates our Fool's Rules, please report it via the Report this Comment Report this Comment icon found on every comment.

  • Report this Comment On February 05, 2011, at 12:24 AM, ConfidentNvestor wrote:

    This author should find an industry to write about that he might understand a little better. Some of the info in this article just isn't true. I don't have a strong opinion either way, but if given a choice, I would rather read factual information. Why spin information to fit your point of view, when the real story 'lies' somewhere else? For instance, the auto industry (especially the domestic auto companies) are making money hand over fist with the current seasonally adjusted annual rate (SAAR). Profits will only get better as the number of vehicles sold increases. But rest assured, posting a $6.6B profit for 2010 with a SAAR of 11.5 million is awesome in any economy. January 2011 sales were just announced this past week. January is typically the softest month of the year and sales turned out to be fantastic, suggesting this year will be better than last, with a SAAR somewhere around 12.5m. The comment this author made about Ford's so-called lack-luster 4th quarter earnings failed to mention Ford's 4th 2010 earnings would have been $1.5B if not for paying off another $1B in debt. I'm not sure why paying down debt is punishable in this environment, but I'm all for a company who continues to better their balance sheet. Further, with commodity prices on the rise and gas prices going out of the roof, it only stands to reason consumers will migrate toward smaller vehicles. The domestic auto companies are 'Johnny on the Spot' (for once!) with their small car lineup currently in place (Fiesta, Focus, Volt, Fusion, etc.). These cars are all offering the latest in technology, which is VERY profitable for the auto companies. In addition to all of this, the average age of vehicles on the road today is 10 years. Their is a tremendous pent up demand for autos. The US auto industry's quality is superior to any other competitor. I just can't see why an author who has a forumn such as this would spend time bashing or bad mouthing the US Auto Industry at a time when there is so many good things to talk about. I don't know about you, but I think the US Auto Industry has finally gotten it right and is poised to continue this tremendous comeback. Our nation will rebound and I think the US Auto Industry will be a key driver!!!!

  • Report this Comment On February 05, 2011, at 3:09 AM, TMFBond007 wrote:

    Hi ConfidentNvestor,

    Thanks for reading and commenting on the article. I'm just curious what isn't factual about the article?

    Obviously you have a strong interest in Ford doing well as you are long the stock. I hope it does well because it is important for our economy. However, i thought its most recent quarter was pretty bad.

    January is a soft month for car sales, but I didn't compare it to other months. I compared it to January, and the numbers are still really bad.

    You also mention that customers are migrating to

    'Johnny on the Spot' vehicles like the very affordable Volt. That's great if its true, but unfortunately the automaker's profits on SUV's and trucks are significantly higher.

    Even mentioning that higher oil prices is a positive at all is quite silly. Commodity prices are soaring, and that is definitely the antithesis of positive or

    'Johnny on the Spot' for this industry right now.

    I appreciate your opinion, and would enjoy hearing more about why you are long Ford, and what impressed you about its most recent quarter.

    Thanks again for reading,

    Andrew

  • Report this Comment On February 05, 2011, at 8:03 AM, exgmbondholder wrote:

    Andrew, this article is spot on! The public has been fooled by overly optimistic reports driven by GM hype. I even saw a piece on US January sales headlining "sales best in two years!" Not many readers would discern that January US sales are the second LOWEST since 1991, only previous year was worse.

    You do a service by offering a contrarian view to the auto sector hype. I believe yours to be the more accurate picture. Please keep up the great work!

  • Report this Comment On February 05, 2011, at 8:10 AM, exgmbondholder wrote:

    PS. The comment by the critical reader praising the Volt tells you everything you need to know about the uninformed public. The Volt?! 321 sold in January and losing money on every one. A car that goes 25 miles on a charge (50 downhill) and then gets 30 miles per gallon for $42,000. What a hoax! The fact that GM spends so much money hyping this vehicle is a sign that they are in trouble regarding product launch. Add the media praise for the Volt and you get a picture of biased reporting.

    I think a lot of small investors are going to get hurt. The big money knows better, that's why GM hasn't shot up to over $40 as predicted by pundits.

  • Report this Comment On February 05, 2011, at 10:48 AM, dockofthebay wrote:

    I believe that the car companies will fare better in 2011 than most investors think. The scrappage rate for older vehicles still exceeded the new vehicle replacement rate, the last that I heard.

    Yes, this year's January sales looked weak compared to the historical numbers, but that is the point. It tells me that we have a big upside out there not too far away- even if it is not in 2011. At some point, people have to replace vehicles or start walking or taking the bus.

    Gas prices where I live are about $3.26 for a gallon of regular. A few years back, that killed sales of pickups and SUVs. This time around, both pickup and SUV sales are strong - at least that is what Ford recently reported (with the exception of the small Ranger pickup). Should gas prices get up to $4.00 or higher, I would be worried and a seller.

    The rising costs of steel and plastics do concern me as well, but I think that in Ford's case the cost savings from the "one platform" effort will help them to offset that substantially.

    Disclosure: I own Ford (F) and American Axle (AXL) and will probably buys shares of CRMT soon. The latter company is big in sales of used cars, which may continue to be the necessary choice for many people who must replace their aging car but can't afford a new one.

  • Report this Comment On February 05, 2011, at 12:26 PM, venus537 wrote:

    Hello Andrew,

    I noticed you didn't rebut the critical reader's point about the large pent up demand for new vehicles. Both GM and Ford are now very competitive against their Asian competitors so it stands to reason they will benefit when consumers start buying new cars again.

    I think it's silly to think new car sales are not going to recover, if not within the year, soon after.

    Exgmbondholder,

    The Volt is advertised to get 40 miles on a charge but road tests have easily beat those numbers. Also, the gas engine mileage is 35-40 MPG.

    If the Prius can become a big seller then the Volt has the potential to do so also. The reason the Volt hasn't sold more than it has is not because these cars are just sitting on the lots but because it's just getting launch and availability is very limited. GM has actually ramped up production of the North American Car of the Year. Who's uninformed!

    I bought more new cars than I care to admit in the last 25 years. I've only purchased Honda/Acura and Volkswagens/Audi vehicles, no GM or Ford vehicles. So It's not like I have a bias perspective.

  • Report this Comment On February 05, 2011, at 12:44 PM, exgmbondholder wrote:

    Venus, Consumers Reports says it got 33 miles on charge and 30 MPG. In cold weather, it will be less than 33 miles on charge. Don't know if this will work, but here's link:

    http://autos.yahoo.com/articles/autos_content_landing_pages/...

    The car loses money for GM, that is why they are limiting production, besides the fact that MPG and electric range are unimpressive and not worth the high price.

    My point was that the media reporting on the industry has been overly optimistic. It is wise to listen to all unbiased opinions before investing in the sector. The Obama orchestrated GM bankruptcy and IPO assured positive coverage, particularly from analysts working for underwriters and TV networks receiving $millions in ad revenue.

    Andrew gave a great unbiased opinion, I think more accurate than you will hear elsewhere. Admittedly, my views are biased against GM. It doesn't mean that I may not be right!

  • Report this Comment On February 05, 2011, at 1:18 PM, spawn44 wrote:

    I agree with Bond. The real story is Ford has made the correct moves to fight against any headwinds that it encounters. They now have cars that can compete and win against the asian competitors. Given the choice, most americans will buy american products is they are available and good quality.

  • Report this Comment On February 06, 2011, at 1:07 PM, venus537 wrote:

    "It is wise to listen to all unbiased opinions before investing in the sector."

    bond, sounds like good advice but just because you agree with Andrew doesn't make him any less bias than the others.

    My main point was that Andrew doesn't acknowledge the pent up demand for new vehicles. I for one don't think consumers are going to buy less new vehicles permanently.

    And I think Ford and GM with their products are in a position to get a good share of the piggy trough once consumers start buying new vehicles.

    I've thought a restructured GM would be a good investment long before the media jumped on the bandwagon.

  • Report this Comment On February 06, 2011, at 2:18 PM, venus537 wrote:

    "The car loses money for GM, that is why they are limiting production"

    False. The car is in limited production because it was never intended to be a mainstream vehicle.

    GM knew this car initially would lose them money as it's a pilot vehicle to be built upon in future generations where its technology will eventually spread to other platforms.

    While your giddy because you think the Volt is a disappointment GM probably couldn't be more giddy for the great publicity and awards the Volt has received. They will have no trouble selling (more likely leasing) every Volt they make this year.

    You can get giddy if GM can't expand on this vehicle to make it profitable but for now it has met all of GM expectations and more.

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