Will a Slowing U.S. Auto Market Clobber Ford Motor Company?

Ford's share of the pickup market has declined this year, a result of constrained supplies as the automaker switches its factories over to the all-new 2015 F-150, shown above. But will a slowing U.S. market limit the success of new Ford products like the F-150? Source: Ford Motor Company.

Has the boom in U.S. auto sales peaked? And if so, is it time for Ford (NYSE: F  ) investors to worry?

Morgan Stanley's widely followed auto analyst Adam Jonas seems to think the market might well be peaking, if it hasn't already.

In a report last month, Jonas said it was becoming "increasingly difficult" for automakers to deliver sales growth "despite ideal credit conditions and higher incentive spending."

Credit conditions have certainly been pretty close to "ideal" for new-car sales. Many buyers have access to low-interest loans with extended terms -- 72 months has become common -- that make monthly payments more affordable. 

But growth in new-vehicle sales has slowed this year, even though credit remains affordable and widely available. Edmunds predicts that Ford's sales will actually decline 1.3% in August from year-ago totals, while the overall U.S. market will rise just 0.7% on the month. 

However, does all of this mean a decline is in store? Is it time to start worrying about Ford and the other automakers that have done so well in the U.S. in recent years?

Can the market really go much higher from here?
Here's one reason to think the U.S. auto market doesn't have a lot of growth left: It's approaching the peaks we saw last decade.

Source: Automotive News (historical figures), Edmunds (2014 estimate).

Edmunds estimates that U.S. light-vehicle sales will total about 16.4 million this year. That's not far off last decade's peak of just under 17 million, reached in 2005. 

It's possible, some observers have argued, that 17 million sales a year is the upper limit of what the U.S. market can generate under good economic conditions. Americans simply don't need more new cars and trucks than that in any given year, the thinking goes.

So what if the market is approaching a peak? What should we expect to see if automakers must fight harder for sales?

Why a discount war could break out soon
Bigger discounts, for starters.

Historically, when growth has slowed in a market, automakers have resorted to steeper "incentives," the cash-back discounts and cheap-financing deals we all see advertised on TV. 

Most automakers won't want to boost incentives. Higher incentives mean slimmer profit margins, and strict discipline around profit margins has been a point of emphasis for managers at most automakers for a while now -- certainly since the financial crisis.

But in the past a few companies resorted to steeper discounts in an attempt to grab market share -- to get sales growth by luring more of the consumers who are willing to buy their products. Or they may increase discounts to reduce rising inventories, as an alternative to cutting production as sales slow.

Either way, a major move to raise incentives by one or two automakers will put pressure on the others to raise their own discounts in an attempt to defend their turf. (This is especially true in high-profit, high-volume market segments such as midsize sedans and pickup trucks, where a small swing in market share can mean a big difference in profits.)

Consumers benefit when this happens, but automakers' profits (and share prices) tend to get squeezed.

So are we seeing bigger discounts in the U.S. market right now? There have been a few limited signs that automakers are more willing to offer deals. For instance, Ford and General Motors (NYSE: GM  ) both started their end-of-season clearance events earlier than usual this year.

But analysts at TrueCar seem skeptical that there's a major increase in incentive spending happening. They point out that while incentive spending by the automakers may be rising, "average transaction prices" -- the average prices paid by consumers for new vehicles -- have also increased. 

They argue that incentives really haven't been rising much, when viewed as a percentage of average transaction prices. This TrueCar chart makes the point:

Source: TrueCar.com.

"[W]e remain upbeat about auto industry sales, segment mix and profitability," TrueCar President John Krafcik said in a statement, while emphasizing that "we continue to keep close tabs on inventories and incentives." 

So if incentives aren't rising all that much -- at least, not yet -- is it really time to worry?

Don't sell your Ford stock yet, but...
I don't think it's time to sell your automaker shares just yet. And to answer the question posed by the headline, while a slowing U.S. market is likely to hurt Ford's stock when it happens, I don't believe Ford or its peers are in danger of seeing their profits and share prices drop in a big way. Not yet, at least.

I'd argue a big decline in U.S. new-vehicle sales won't happen until the U.S. economy takes a significant turn for the worse. 

But I do think that we could be coming to the end of the big auto-sales growth streak seen over the last few years. And that means it's time for investors in Ford, GM, or other automakers that are heavily dependent on the U.S. market -- which is most of them -- to follow TrueCar's lead and start paying close attention to sales growth, incentives, and inventories every month. 

Because the truth is, that decline will happen, sooner or later. 

Ford's profits in North America may well start to erode before a decline happens, if a discount war breaks out. That would almost surely hurt the stock. As you can see from this chart showing pre-tax earnings in each of Ford's business units last quarter, Ford's profits in North America have been carrying the company recently.

One last thought: all Automakers represent cyclical investments. Simply put, they'll make more money during good economic times and get squeezed during recessions. 

Generally speaking, their stock prices tend to fall when their profits shrink, as you'd expect. That can be a buying opportunity for those with a long-term view. But other investors might sell before that happens, when profits seem to be peaking.

As a Ford investor, I think we're not there yet. But it's time to start thinking about it. Stay tuned. 

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