Is the Automotive Bull Run Over?

Sales remain low. Should we stop expecting a further recovery?

John Rosevear
John Rosevear
Jul 8, 2011 at 12:00AM

Bulls hoping for a big move up in U.S. auto sales were surely disappointed by June's numbers. While overall U.S. light-vehicle sales were up 7.1% over last year, the SAAR (for "Seasonally Adjusted Annual Rate," a closely watched annualized estimate of auto sales) was a mere 11.4 million, the lowest number of the year.

That number was depressed somewhat by vehicle shortages due to the ongoing recovery in Japan, but the larger issue for our purposes is this: Even if the automakers sell 12.5 million vehicles in the U.S. in 2011, that's far below the sales total seen in the year before the economic crisis in 2008. The 16.15 million vehicles sold in 2007 were cited as the lowest level in a decade.

Put another way, the overall vehicle sales rate in the U.S. is about three-quarters of what it was before the economic crisis -- despite the significant improvements to the economy since the dark days of early 2009.

Is it stuck? If so, what are the implications for auto stocks?

A big break in the trend line
For many auto investors, the question of better vehicle-sales trends is only now coming into sharp focus. Until recently, the bull cases for companies like Ford (NYSE: F) and General Motors (NYSE: GM) have been more about the individual companies' turnarounds than about prospects for the industry as a whole.

But these turnarounds are maturing. Ford still has a large-ish debt load to pay down, but its cash hoard exceeds its debt burden and all signs are that management has things in hand. And I might argue that GM still has a lot of work left to do on its product portfolio, but the company is solidly profitable and out of danger.

Increasingly, a bull case for either automaker (as well as for others) will need to rely on prospects for earnings growth. While both companies will continue to find growth in emerging markets like China, those sales aren't as profitable as those in developed markets. They'll continue to compete for small market share gains in the U.S. and Europe as well, but those aren't likely to amount to a whole lot on the bottom line.

A lot of work for incremental gains
It may well be that the leading automakers spend the next few years making massive investments in product simply to hold the market share they currently have. Individual companies' prospects will ebb and flow over time with their product cycles, as hot products command bigger margins. Right now, Ford and Hyundai (OTC: HYMTF) are strong, Honda (NYSE: HMC) and Toyota (NYSE: TM) have faded a bit, and Volkswagen (OTC: VLKAY) and GM are on upswings.

That pecking order may shift some as each company's post-economic-crisis product-development efforts begin to show fruit, but those gains are likely to be incremental -- unless the overall level of sales in the all-important U.S. market rises significantly.

But will it? For every "expert" who thinks it simply has to -- vehicles wear out and will need replacement eventually -- I can find another who will point to the obvious counter-theory: That last decade's high sales numbers were inflated by consumers' willingness to go way into debt and the easy availability of credit. Personally, I think that sales will eventually hit 14 million or 15 million again at some point within the next several years, but will it be one year or seven before that happens?

I don't know, and right now I don't believe anyone who says that they do.

Making hay right now
I had a conversation with Ford CEO Alan Mulally last fall in which he spoke with obvious relish of the opportunity Ford would have once the SAAR got back up over 14 million or so. Not long ago, Ford (like the other Detroit automakers) was solidly profitable during economic booms, but was a money-loser during recessions. One of the goals of Ford's turnaround plan was to lower the company's breakeven point far enough that it could stay profitable (or at least, not lose money) during harder times, something that Ford executives felt was critical to the company's long-term survival.

Ford has obviously met that goal, having posted several strong quarters despite the subdued sales level, while also retaining the capacity to scale up production without massive capital investments. It's clear where Mulally's excitement was coming from: Given the low additional investment necessary to make them, those additional sales will be very profitable. As a Ford investor, I shared his enthusiasm.

I think there's still room for Ford and GM to grow as those companies continue their recoveries. But after that? As in so many other sectors right now, prospects for growth seem awfully cloudy.

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