Tom Webb's Blog (Manheim Consulting)

Dealerships Post Sales Growth, Record Profits, and Narrower Margins

Same-store used vehicle retail unit volumes for the seven publicly traded dealership groups rose 6.5% in the first quarter of 2013.  It represented the 15th consecutive quarter in which there was a gain.

Higher volumes were accompanied by greater operating efficiencies, faster inventory turns, and strong F&I income.  As a result, profits were at record levels despite the ongoing decline in gross margins.  Quarterly margins relative to their year-ago level have declined for 13 consecutive quarters.

Given that future F&I income will likely be under greater pressure, dealers will need to stem in the deterioration in upfront grosses.  But, given the competitive nature of the used vehicle marketplace, it is unlikely that margins will increase.  So, from our last posting on the dealership groups, we would repeat the two implications that flow from narrow margins.

• Thinner margins mean that the linkage between the retail and wholesale market will become tighter.  Changes in one market will be more quickly, and more acutely, felt in the other.  With the cushion of wide margins gone, look for subtle shifts in retail demand to be quickly reflected in wholesale buying.

 

• As average margins narrowed, so too has the range of grosses on individual transactions for individual dealers.  Lacking “home-run” (high gross) deals, dealers can now ill afford the outsized losses associated with buying the wrong car at the wrong price.  So, for commercial consignors, who often benefited from that one dealer paying too much in a speculative bid, the need of getting their portfolio in front of right buyer - the first time - takes on added importance.          

Vehicle Miles of Travel Slips Further From Previous Peak

Monthly vehicle miles of travel (VMT) declined 1.4% in February versus a year ago.  This pushed annual VMT 2.8% below the previous peak reached in November 2007.  Some of February's declined can be blamed on gas prices and weather, but the long-term weakness is clearly shown below.  Analysts should incorporate this factor into their long-term forecasts for new vehicle sales and vehicles in operation.  

Ford 1Q release: Off-lease up (driven by 2yr terms), repos flat at a low level

An update to my two regular favorite (for obvisous reasons) slides from Ford's Fixed Income Conference call today.

Off-lease volumes up - driven by 2-yr leases.  Look at the spread in value between 2yr and 3yr eot units

 

Repo volumes flat at very low level 

Driving Less and Paying More

Total vehicle miles of travel (VMT) declined 2.9% in December 2012 versus December 2011.  Not surprisingly, the biggest drop was recorded in the Northeast.

For the full year 2012, VMT rose just 0.3%.  Relative to the peak reached in November 2007, VMT (on a 12-montrh rolling basis) is now down 3.3%.  As the graph indicates, it is now much more likely that even employment will get back to its previous peak before VMT does, especially given the approximate 50-cent increase in gas prices so far this year.

A 4.9% increase in insurance costs over the past year is also weighing on drivers.  That rise occurred despite a sharp drop in accident rates.  Blame it on the inability of insurance companies to earn investment income in today’s low interest rate environment.

The sad fact is that even though consumers have curtailed unnecessary driving, bought more fuel efficient vehicles, and driven more safely, it still costs them more to get from point A to point B.  

Remarketing Strategies and Results Will Be Influenced by Narrowing Dealer Margins

Same-store used vehicle retail unit volumes for the seven publicly traded dealership groups rose 8.5% in the fourth quarter of 2012.  It represented the fourteenth consecutive quarter in which there was a gain.  And, for the full year of 2012, these seven dealership groups had a total retail unit volume that exceeded the one million mark for the first time ever.

Higher volumes were accompanied by greater operating efficiencies, faster inventory turns, and strong F&I income.  As a result, profits were at record levels and, thus, the ongoing decline in gross margins raised little concern.

That does not change the fact that wholesale buying and selling strategies have been, and will continue to be, altered by the narrower margins.  For one, thinner margins mean that the linkage between the retail and wholesale market has become tighter.  Changes in one market will be more quickly and more acutely felt in the other.  With the cushion of wide margins gone, look for subtle shifts in retail demand to be quickly reflected in wholesale buying.

In addition, as average margins narrowed, so too did the range of grosses on individual transactions for individual dealers.  Lacking “home-run” (high gross) deals, dealers can now ill afford the outsized losses associated with buying the wrong car at the wrong price.  So, for commercial consignors, who often benefited from that one dealer paying too much in a speculative bid, the need of getting their portfolio in front of right buyer - the first time - takes on added importance.          

Real GDP & Auto Sales

It’s time to add another year to this interesting graph.  Each dot represents one of the 58 years between 1955 and 2012.  The x-axis shows the annual percent change in real GDP for that year and the y-axis is the percent change in new vehicle sales.  Naturally, there is strong correlation.  A correlation that quantifies just how much new vehicle sales have outperformed the overall economy in this recovery.

Two outliers are noted in the chart above.  At the far right, close to the horizontal axis, we see that in 1966 new vehicle sales declined 2.1% even though real GDP grew by a very strong 6.5%.  Why’s that?  It’s because new vehicle sales had already increased dramatically in each of the prior four years.  (New vehicle sales first exceeded the ten million mark in 1965.)

As an opposite case, note that in 1982 new vehicle sales declined by only 1.9% even though real GDP dropped by 1.9%.  (Up until our recent recession, that was the largest decline in real GDP in post World War II history.)  The disconnect is because new vehicle sale had already fallen significantly in 1979, 1980, and 1981, producing a peak to trough swing of 31%.

By just ignoring those two outliers, the R-square increases from .60 to .68 for the remaining 56 years plotted.  If we also ignore 2010 to 2011, the R-square rises to .75. 

Why ignore the last three years?  Were they really outliers?  Yes!  Only three times in the past 60 years has a double-digit increase in new vehicle sales occurred when real GDP was growing less than 3.4%.  Those three years came consecutively:  2010, 2011, and 2012.

Another factual tidbit: only one other time in the past 60 years have new vehicle sales increased at a double-digit rate for three consecutive years.  That was 1971, 1972 and 1973.  Hmmm…, 1974 wasn’t such a good year (trust me; I was an auto analyst at the time).

But don’t expect 2013 to be a repeat of 1974.  It is true that strong cycles produce outliers.  And that after an outlier there is a movement closer to the regression line.  That will occur this year, but there is no reason to believe we will fall significantly below the regression line.

Ford Credit: two-year lease returns up, repos down

Slides from today's Ford Motor Company 4th Quarter 2012 Fixed Income Conference Call.

Note that two-year lease returns actually exceeded combined 3-year and older lease returns.

And repo rate was a multi-decade low.

 

 

It’s Time to Spike the Punch

The vast majority of economists believe that the decision by the Federal Reserve to pay interest on bank held reserves was a good one, and that lowering the rate to zero now would have no material impact on bank lending.  (Ironically, some of the very same economists believe that raising the rate on reserves will prove to be an effective new tool when the Fed needs to reverse course.)  And there is also a small, but philosophically diverse, group of economists who believe that paying interest on bank reserves is counter-productive to the objectives entailed in three rounds of quantitative easing.

It’s a complex and nuanced issue.  So, to simplify, let consider that old analogy that says the Federal Reserve’s role is to “remove the punchbowl before the party gets out of hand.”  Of course, following the financial collapse of 2008, that analogy was turned on its head and the task of the Federal Reserve became “make more punch”.  And make more punch they did!  In fact, after buying $2 trillion worth of Treasuries and mortgage-backed securities, the Federal Reserve, as of last week, had $2.946 trillion in punch available.

But, they haven’t had many sippers – and certainly no drinkers.  Hence, my suggestion: “Spike the Punch”.  Translated: buy beyond the scope of mortgage-backed securities.

And then, to top it off, charge banks to hold reserves (i.e., a negative interest rate).  Think of it as a cover charge that includes two free drinks.  Know many people who pay the cover and then fail to consume the free drinks?

Furthermore, while we’re at it, let’s lower the drinking age and stop checking ID’s.  In other words, loosen up some of those mortgage lending standards and streamline the process.    

All of the above is heresy to a monetarist, such as me.  But these are still unusual times.  The solutions, both tried and offered, to date have been inadequate.  Consider the deficit debates.  The high-minded speak of the need for a “balanced” approach – spending cuts and tax increases.  The fact is – that’s not enough.  We can only get out of our current deficit dilemma, and the impending demographic time bomb of entitlement spending, with faster economic growth.  Another year with fewer than two million jobs created and less than 3% growth will just put us deeper in the hole.  It’s time to cast caution aside, drink up, and get the party going.

Wholesale Values: Which Price Tiers are the Strongest?

To consider relative pricing strength between various vehicle price tiers it is useful to look at changes in average mileage for each of those tiers.  An increase in average mileage for vehicles within a given tier means that prices are strengthening since it implies that dealers are willing to spend the same amount of money for a vehicle with higher mileage.

Shown below is the change in average mileage (in both absolute and percentage terms) for several broad price tiers for the first ten months of this year versus the same period in 2010.  All tiers show an increase in mileage, with the biggest increase in average mileage (or pricing strength) occurring for vehicles in the $8,000 to $11,000 range.  Simply put, if you paid $9,500 for a vehicle at auction in 2010 you got, an average, one with 58,500 miles.  This year, that same $9,500 got you a vehicle 78,700 miles on the odometer.

(This shorthand method of equating how many more miles a dealer is willing to accept at a given price is not a perfect representation of pricing strength as it can be influenced by mix shifts in market class or models.  Also, per-mile mileage deductions in the real world are naturally higher for lower-mileage and higher-priced vehicles.  And, in the lower price tiers other factors can easily swamp the impact of mileage on price.)

Each dot in the following graph represents the change in auction share versus the change in average mileage for each price tier.  The horizontal axis represents the percentage point change in auction share volume.  (Since this is a change in share, approximately half of the tiers show a gain and half show a loss.)  The vertical axis represents the percentage change in average mileage for the price tier.  (Changes range from -2% to +36%.)

When there have been large movements in auction volumes and pricing (like between 2010 and 2012), you find individual price tiers where there has been big change in available supply and average mileage.  And, naturally, the line is downward sloping.  In periods of more stable auction volumes and pricing (like between 2011 and 2012), the slope is less steep and the relationship less strong.

The Lagging Used Vehicle CPI Misleads

There are several earlier posts on this blog that described some of the failings (both in data and methodology) that result in a less-than-perfect used vehicle component of the Consumer Price Index.  Over long periods of time, however, the Used Vehicle CPI does roughly reflect the true course of used vehicle values.  That is confirmed by the close correlation to the Manheim Index.

But that true trend is always revealed on a delayed basis.  That’s because the Used Vehicle CPI is based on a three-month moving average of data that had already been previously smoothed.  The graph below shows the degree to which the Used Vehicle CPI lags the Manheim Index.

Today’s release of the CPI had used vehicle values falling 0.9% in October versus September.  The Manheim Index, released more than a weak prior, had used vehicle prices rising by 1% in October and the year-over-year declining diminishing.