Discounts are Rising, but Auto Sales Are Probably Stuck

By John Rosevear Markets Fool.com

Discounts are rising -- but U.S. auto sales probably aren't.

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That's likely to be the story when the automakers release their February U.S. sales results on Wednesday, according to new estimates from J.D. Power. And at least at first glance, the estimates don't bode well for profits at the automakers with the biggest shares of the U.S. market, namely Ford Motor Company (NYSE: F) and General Motors (NYSE: GM).

Incentives are rising but sales look roughly flat

The February forecast, developed jointly by J.D. Power and analysts at LMC Automotive, calls for U.S. light-vehicle sales in February to rise just 0.6% from February 2016. ("Light vehicles" is the industry term for cars, pickup trucks, and SUVs.)

That roughly flat year-over-year result is despite spending on incentives, or automaker-funded discounts and cheap financing, that totaled $3,748 per vehicle in the first 12 days of the month -- the highest level ever recorded for the month of February.

Incentives on General Motors' Chevrolet Silverado were up sharply in February from a year ago. Image source: General Motors.

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Some of the increase over time is simply because the average new vehicle is more expensive. The report noted that the average transaction price over that same period was $31,483. That's also a record.

But when those incentives are looked at as a percentage of the average transaction price, we see that it's 10.3%. That's the first time the percentage has exceeded 10% in February since February 2009, when the new-car market was in very tough shape.

This time around, discounts aren't rising because the market is in tough shape. Here's how LMC's senior vice president of forecasting, Jeff Schuster, sees it:

Light-vehicle demand in the United States is tracking as expected and maintaining a strong overall level of demand. It's influenced by variables that will be playing out as the year progresses, including level of economic growth, a potential border tax, lease maturities and the introduction of more than 60 new models. In addition, the balancing act between relatively high inventory levels and incentive spending will be closely watched as an indicator for the health of the auto industry.

So why are incentives trending up now?

Trying to create sales growth in a flat market

What's happening is that while the overall level of sales is very high, it's not meaningfully higher than it was a year ago. That means the market is no longer driving sales growth. In order to generate sales growth, automakers need to take sales from rivals. Discounts are one way to do that.

Not all automakers want to boost their discounts. Some, including Ford, have made it very clear that they will resist the temptation to boost incentives. Instead, Ford, GM, and some others say they are determined to match their production to demand as it rises or falls. The hope is to avoid a situation in which inventories are rising and the companies have to resort to discounts to move a surplus of vehicles.

But when some automakers decide to discount in order to generate sales growth, that puts pressure on the others. We'll find out on Wednesday who felt that pressure the most.

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John Rosevear owns shares of Ford and General Motors. The Motley Fool owns shares of and recommends Ford. The Motley Fool recommends General Motors. The Motley Fool has a disclosure policy.