Auto sales have been rising steadily since 2009, and are just now starting to drop off as of this August.
In this episode of Industry Focus: Industrials, host Sarah Priestley talks with Motley Fool senior auto specialist John Rosevear about what's leading the slowing growth and what this means for the industry in the long term. Find out why prices are starting to back out now, how things like used-car sales and leases are affecting the big automakers, which companies and types of vehicles are actually seeing growth, and more. Also, the hosts look at the most exciting upcoming new cars from many of the biggest automakers and how much they might move the needle for their companies.
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A full transcript follows the video.
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This video was recorded on Sept. 21, 2017.
Sarah Priestley: Welcome to Industry Focus, the show that dives into a different sector of the stock market every day. Today, we're talking energy and industrials. It's Thursday, 21st of September, and we're going to be discussing the U.S. auto market. Joining me on Skype is Motley Fool contributor and senior auto specialist John Rosevear. Hi, John!
John Rosevear: Good morning! Good afternoon, listeners!
Priestley: Thank you very much for joining me today. How's your morning going so far?
Rosevear: So far so good. Just watching all the news emerge on electric cars and so forth. That's the big thing right now. That'll be another show.
Priestley: AMD is taking Nvidia's breakfast?
Rosevear: I don't know.
Priestley: I've just read the headlines.
Rosevear: It's a much longer story than I think we have time for. There's a longer story there as to Tesla's relationships with some of its key suppliers and what exactly happened there. But we'll talk about that another time.
Priestley: I'm sure we will. It shows you how misleading headlines are, and how uninformed I am. So, we're going to talk about the auto industry today. After posting record sales in 2016, selling 17.6 million units, automakers are starting to see a slowdown. Sales of automobiles are down 2.1% for the first six months of this year, and the Detroit 3 -- Ford (NYSE: F), GM (NYSE: GM) and Fiat Chrysler (NYSE: FCAU) -- all posted declines for the first half of the year. GM sales down 1.8%, Ford 3.8%, and Fiat Chrysler almost 7%. So, John, this year looks likely to end the two years streak of record sales. The narrative in the press right now is very much on the wider debate of, have we reached peak auto? You've been in the industry for 20 years, commentating and being an analyst, so I wondered if you could us the long-term view on this?
Rosevear: Auto sales are cyclical. They're somewhat of a leading indicator, we say, because when consumer confidence starts to fade, people don't buy new cars. Business is also don't buy new cars, and commercial sales are very important for some automakers, in particular Ford and GM. But, looking a little bigger picture, we've been in a rising cycle since late 2009. We all know the economy and auto sales blew up in 2008, and they stumbled around in 2009. But if we had a graph of this, and Sarah and I did earlier so you'll just have to play along by audio, you'd see the pace of auto sales picking up steadily from about the end of 2009 through about the end of 2015. And it went up and down last year, just enough to eke out a record over 2015, but then it's been coming down in 2017. You look at that, and the obvious conclusion that suggests itself is, we're past the peak of the auto cycle, and that has some implications.
Priestley: Absolutely. Just to play devil's advocate for one moment, some people are suggesting that there's currently issues at the minute that are different and more stressful for the industry that we haven't seen before. For example, the glut of used vehicles. In 2014, 3.3 million vehicles were leased, which was 23% of auto sales that year. The suggestion that we're seeing is that this is going to create an overall glut in the market and pressure prices down. We haven't seen that yet in new car sales. What do you make of this? Do you think that's going to happen?
Rosevear: When you have a glut of used car sales, we point to a couple of things that happen right away. First of all, the prices of used cars, nice, lightly used cars, the kind of cars you get off lease, are under some pressure. They're slipping. That has a couple of impacts on the automakers from an investor's perspective. First of all, a lot of these leases are underwritten by captive finance units. Ford has an in-house bank, Ford Motor Company Credit. Ford Credit is bringing these leased vehicles from 2013 and 2014, whatever, to auction, and they're getting less than they expected. That impacts the profitability of those lease deals they did two or three years ago, whatever it was. It also makes it a little harder for them to lease now, because of course, leases are priced on what we call residual value, which is the predicted value of the car at the end of the lease. Values are coming down now, that means the analysts who rate residual values for the automakers are going to bring values down. And that means they have to either price to leases higher to the consumer, the monthly payments have to be higher, or the profits get squeezed if they're going to hold the levels. That makes it a little harder to lease. You see some automakers actually backing away from leasing somewhat because of this, because the profitability is not what it was. So, there's that too.
Impact on new car sales, we haven't seen a lot of that yet, but if the economy starts to slide, you will. You sure will. And that supply will get bought up. When consumers are feeling pricing pressure, they postpone new car purchases that are optional many times. But if they need a car, they may limit their spending and say, "I'm just going to get a used one now and I'll replace it when things improve." There are a good number of people, not so much business is, but individuals who do that, and that'll suck up some of that excess inventory if it starts to happen soon. If not, used car prices will be under pressure.
Priestley: Yeah, I think they've slipped 6% so far this year, but dealers are maintaining that discipline in terms of not slashing prices indiscriminately that we have seen before. There are the longest term loan offers in the industry's history. Is that carried by the dealer, or is that carried by the automakers themselves?
Rosevear: The automaker's captive finance unit makes a percentage of the loans that their dealers make. The dealers often work with independent companies as well. For instance, to go back to the Ford example, Ford has an optimal credit profile, and folks who come in with lower quality credit, the dealer may know other financing companies that will work with them if Ford would rather not have that deal or won't offer it at a competitive interest rate. But, what we see going back to the way we framed all this, with the cycle in decline, the pace of sales slowing, what happens is, to show growth, some of the automakers will resort to jacking up discounts. Generally speaking, historically, this is what has happened. You see incentives go up. Those incentives, the cash back or 0% financing or price cuts, those are financed by the automakers. And the higher they go, the bigger the squeeze on profit margins that comes out of their profit margins. We have seen, we've heard a lot of talk over the last five to eight years, really since 2009, about how we're going to resist the temptation to boost our discounts, we're going to cut production rather than discount in order to keep sales up. We would rather lose the incremental sales and maintain our profit margins. Mostly, we're seeing that. This was notably the talk of, former Ford CEO Alan Mulally was famous for this. We'll match supply to demand, we'll match our production capacity to demand, meaning that will move it up and down to keep inventories from getting out of hand. GM has been doing it for the most part. Their incentives haven't come up too far. Ford's haven't come out much at all. Some other automakers are discounting more aggressively. Whether that puts further pressure on companies like Ford that are trying to hold the line over time, we'll see what they think the optimal business decisions are. But so far, the discounts aren't skyrocketing. Ford would rather come in and say, "Sales were down 2% last month," than say, "We gave away some profit so we could show a gain."
Priestley: I think it really shows that they must have a finger on the pulse for the market, if they can respond that quickly. I know manufacturing cycles probably aren't that long, but they are long enough that they would really have to be ahead of the game.
Rosevear: They mostly are. I mean, obviously, they talk to their dealers all the time. There are people at Ford whose job it is to talk to dealers and get the sense of this. And all the other automakers, as well. And that turn feeds into production decision. It doesn't quite move that quickly, like, "Trucks are off this week, let's cut trucks next week." It's not quite like that. It's more quarter-by-quarter. But, yeah, it's fairly quick. It's quicker than it used to be.
Priestley: I mentioned a little in the intro about the first six months of this year. August results show that cars and trucks declined to 2%. Some of this can be attributed, interestingly, to Hurricane Harvey which has affected auto sales to the tune of about 20,000 cars, Houston being the ninth-largest vehicle market in the nation. I gather, John, this is a double-edged sword, given that the storm can boost sales, unfortunately, as people replace flooded vehicles. What do you make of that?
Rosevear: It's hard to say how this will play out. I saw one estimate that said 200,000 vehicles had been lost as a result of Hurricane Harvey flooding. Houston area is a big market in particular for Ford, for trucks and so forth. General Motors, the GMC brand is very strong in the Houston area, as well. Ford's truck sales weren't bad last month. But there is a sense that their dealers have lost some inventory, although less than a lot of people expected. So, Ford and GM and the other companies will replace that, and that'll give them a little boost, and those cars will go on to be sold and drive up auto sales generally. It's hard to say right now. The impact is not dramatic, though, I think. Of course, we got more hurricanes out in the Gulf, so who knows?
Priestley: Yeah, I know, who knows. It's awful if you live there. But a lot of these automakers really need a boon. If you look at the numbers for a Hyundai, sales were down 25% in August. Nissan, 13%. Fiat Chrysler, 11%. Some bright spots in the August numbers -- GM sales were up 7.5% year-over-year. Toyota, 7%. Volkswagen, 9%. So, these three automakers that fared pretty good in August have one common theme -- they all posted strong SUV, crossover and light truck sales, which we're going to talk about a little bit in a moment. So, John, after that, we mentioned before that GM sales were up 7.5% in August, in no small part thanks to their line of crossovers. Is that right?
Rosevear: GM has been rolling out all new versions of its whole crossover line, starting a little over a year ago. They're coming out in phases. I went to a press conference at GM headquarters in January when I was in Detroit, and I remember Mary Barra saying, "Yeah, we see the U.S. market weakening a little bit, but we think our new crossovers are going to help carry us, even if the overall market starts to soften, and preserve profitability," because new products, generally speaking, can be sold with slimmer discounts, even in a healthy market. So, they tend to be more profitable, especially if they're strong entries. And some of GM's crossovers have been quite good. These are Chevy, GMC, Buick and Cadillac crossovers. There are a couple more coming this fall, and then more new Cadillacs next year. But, there are a whole bunch of new ones. Chevy Equinox, the GMC Acadia and Terrain, the big Buick is coming this fall, the big Chevy Traverse is also coming this fall. It's a whole family, they've been working on this for a few years now. Sales have been very strong. Equinox sales were huge last month, it was up some ridiculous number year-over-year.
Priestley: 47%, I think.
Rosevear: And the old one was not a Chevy seller. It was a dated product, but they had still been doing well with it, just because there's such tremendous demand in that market segment.
Priestley: Yeah, you're absolutely right. I find this whole storyline pretty fascinating, the changing consumer preferences to SUVs and crossovers. Car sales are becoming a smaller part of the market. I think it's now pegged at 38% of the overall market. Last month, light duty sale trucks were up 3.3%, crossovers a whopping 7%, large SUVs up almost 5%. So, it's a bright spot in the market that needs this right now, and like you were saying, Mary Barra talking about them carrying them through this weak moment. And I know a lot of the autos are thinking the same thing.
Where do you think this is coming from? Do you think it's just the result of consumer confidence? Or do you think this is a long-term change in preferences?
Rosevear: I think it's a long-term thing. We started talking about this three or four years ago, even before oil prices fell. What has happened, go back 10 or 15 year, SUVs were truck-based. They were built on pick up platforms. They were heavier, they got truck-like fuel economy, which is to say not great. They rode like trucks. Go back and look at a 2004 Ford Explorer. It's a truck. Whereas the modern Ford Explorer, and these other things, we call them crossovers because they cross the capabilities and general shape and size of SUVs, but they're built on car architecture. They're unibody instead of body-on-frame, for listeners who know what that means. They're built more like cars rather than trucks. They're lighter in weight, they handle more like cars. They get somewhat better fuel economy just because of that change. They are, of course, much more fuel-efficient engines now than were available 15 or 20 years ago. That's another thing.
So, people have been seeing these really all through this cycle, since 2010, 2011 and so forth, more and more as the sensible alternative. It gets the fuel economy of a car, it has the ride comfort of a car, it's easy to drive like a car. But it's got tons of space for your junk in the back, it's got room for five kids or seven kids or whatever, you can fit half the baseball team in there. I was a baseball parent when my kids were younger, I can relate to this. It's an alternative to what people used to buy minivans for 15 or 20 years ago. But people think there's somewhat cooler looking. Male customers who might have winced at a minivan, look at a crossover SUV and go, "Oh, yeah, that's more my thing." But, at the same time, female customers who might have winced at a truck like a Ford Explorer 15 years ago, they take a drive in it and go, "Oh yeah, this is more my thing." [laughs] It's just hit this sweet spot of engineering and development where they've become very popular. And people are coming in with their Camrys and Accords and Fusions and Chevy Malibus and so forth that maybe they have driven for two or three generations and saying, "This time, I want one of those. I want a RAV4, I want a Ford Edge," or whatever, these new crossovers from GM. And more and more people are migrating to them, because they make more sense for families and for empty nesters and even for older folks. If you have lower back problems, it's a lot easier to get out of something like a Chevy Equinox and into it, or a Toyota (NYSE: TM) RAV4 or whatever it is, to get in and out of a relatively low-slung sedan.
Priestley: Yeah. I noticed a lot of the commentary around this is focused on being in a prime position where Baby Boomers are looking to get the comfort of a large vehicle, Millennials are growing their families so they're wanting the space, as you said. So, you're seeing this mentioned a lot in the earnings calls. Toyota sales chief saying the consumer demand for light trucks has shifted, I need to build more light trucks and rebalance our car mix. You're seeing it all over the place. Honda is also, the Honda Division also commenting, many automakers are looking for signs of stability as consumers continue to head toward trucks and SUVs.
Rosevear: Honda and Toyota both had a funny problem last year. They were selling literally all of their compact crossovers that they could get to the United States, so they both needed to look to ramp up production of Toyota's RAV4 and Honda's CR-V, which they have been able to do, but they haven't been able to show sales growth even though they were selling them very quickly. They just didn't have any more available. The production lines that existed to supply this market had been maxed out. So, they have reconfigured production to get more here. But, those vehicles are doing very well. Nissan's Rogue is also doing very well, they're selling a ton of those. It's another vehicle in the same category, the compact crossover.
Priestley: And outside of the compact crossover, more toward the bigger SUVs, I think it's going to be interesting for investors to watch what the Bronco might do for Ford. I think it's anticipated to launch in 2020. It was discontinued in 1996. The marketing says it's going to be back and better than ever. We'll see. I think, for me, I'm going to be looking at, what is this going to do for Fiat Chrysler? Because it's certainly going to be a competitor for Jeep, especially as there's a rumored premium off road version. So, what do you think?
Rosevear: The Bronco relates into another story, which is that for years, Ford sold a one size down pick up. Ford's bread and butter is the F-150, the F series, the F-150 and those super duty siblings, the big pickups. It's America's best-selling vehicle line. They're everywhere. If you live in America, you've seen an F-150 in the last couple days. They're just everywhere. Ford makes a ton of money off of them. For years, they sold a one size down pick up call the Ranger. The Ranger was discontinued in the United States because they closed the factory that made it, which was in St. Paul, Minnesota, in I think the end of 2009 or thereabouts. It was one of the things they did after the economic crisis to ratchet down costs, because they felt like most of those buyers were likely to select F-150s instead because they had just revised the F-150, and so on. Ford launched and all new Ranger overseas. It was designed in Australia and it sold in some parts of the world as a commercial vehicle, and in other parts of the world, like Australia, it's very popular as a 4 by 4. People who would buy Jeeps here often by Ford Rangers and go rampaging around the outback. Well, Ford hasn't had the Ranger in the U.S. in several years. Meanwhile, GM has launched all new midsize pickups, the Chevrolet Colorado and GMC Canyon. GM pitched them a little differently. Rather than an inexpensive utilitarian truck, which is what the Ranger was years and years ago, these are somewhat more premium vehicles. They're an alternative to SUVs for young customers who maybe have hobbies in the woods where they're taking dirt bikes into the woods or mountain bikes or whatever, ski equipment, it's sort of the outdoorsy lifestyle vehicle, available in four-wheel drive with good off-road capabilities and so forth, but also with nice interiors, with leather, with a good stereo and stuff that maybe wasn't emphasized before.
And GM is not selling these in the kind of quantities it sells its big trucks in, but it's selling a fair number of them. Maybe 15,000 or 20,000 a month. And they're getting good profits at good margins. This is the market the Toyota Tacoma plays in, as well. That's the other competitor here. Ford says, "We have this factory in Michigan where we build the Focus, the Compact, and the C-Max," which is their hybrid. "Sales are declining, these aren't that profitable, let's move production of these out of the United States, and instead, let's use that factory and build the Ranger at that factory." And then they said, "Let's keep that factory busy, let's design a brawny, off-road SUV based on the Ranger's chassis to go with it. What do we call it?" This was probably a two second discussion. "We call it Bronco, of course." This is going to come back, I think it's going to be a niche product. I think it's going to be Ford's take on the general idea of the Jeep Wrangler, which is what the original Bronco was way back in the 1960s. It's not going to sell 30,000 a month like the RAV4, CR-V does, or even 25,000 a month like something like the Escape does. It's a niche product. It will help keep that factory at full potential. They'll probably have two shifts on for a while producing Rangers and Broncos. It will flesh out their offerings. It's an easy product for them to do because it's based on the architecture of the Ranger. They'll do it with dramatic styling, it'll improve their image they'll sell it at fat profit margins, people will love it. [laughs] I mean, I really think this is the way this is going to go. Will it make a huge dent in Jeep sales? Probably not. I think a lot of this will be incremental sales. This will be people who might have bought a Ford pickup who say, "I want that instead." Or, people who have a Ford pickup for work and want a weekend vehicle, and maybe they would have bought a Mustang once upon a time, and now they buy something like the Bronco instead.
Priestley: Yeah, I know a few people who are really factoring the Bronco into their bull thesis on Ford as a reason for a buy. But, from what you're saying, you think it's overblown, the anticipation is a little too much. It's not going to be that accretive.
Rosevear: I don't think it's going to double Ford's profits or anything. I think it will be a successful product. I think it will meet or exceed Ford's goals for it. I think it will be very profitable. If you are expecting F-150 numbers on the Bronco, you're going to be sadly disappointed, it's just not going to be that kind of product. Look at what Jeep sells with the Wrangler, and figure some percentage of that. I think that's 15,000 or 18,000 a month, somewhere in that neighborhood. A good, solid, profitable vehicle. You'll see them out on the roads. But it's not going to transform Ford's North American business by itself. On the other hand, it will be good for a lot of attention, a lot of brand building, a lot of media play. And Ford likes that, and that helps them indirectly.
Priestley: To finish off then, with this kind of move toward SUVs and crossovers, who do you think is the one to watch of the Detroit 3 for investors today?
Rosevear: I like where GM is going right now, just because their crossovers are very fresh. Ford's are honestly a little bit dated right now. The Escape is a few years old, the Explorer dates to 2011 or 2012, I would have to go look at my notes. But, some time. These have been refreshed and updated and so forth. But, I know the Explorer has lost some sales to some extent against competitors like the Toyota Highlander and so forth, which is a newer, fresher product. The Edge is fairly recent, 2015. But, GM has all of these crossovers coming out right at once. The GMCs came out last year, and over the winter the Equinox started shipping earlier this year. As we mentioned, that's a huge seller. The big Traverse is all new, it's much better looking, that's their 7-seat vehicle that competes with vehicles like the Explorer, the Chevrolet Traverse. That's coming out this fall. The upscale version of that is the Buick Enclave, that's also coming out this fall. Then, in luxury, Cadillac only has one crossover right now, and it's just a matter of, they had to prioritize things and they did the sedans first, and as they did them, the market went toward crossovers. Well, that happens in the car business sometimes. But they have, I think, three more crossovers coming over the next two years. Those will not be selling in giant numbers, because luxury vehicles don't, but they will deliver a lot of profit per sale to GM. And those are products that will not just do well in the U.S., they'll also do well in China, which is also going nuts for crossovers, by the way.
Priestley: Yeah, it seems like a worldwide phenomenon. OK, on that note, GM, probably a stock to watch. I'm sure we will be talking on the show again about maybe what we mentioned right at the start, AMD and electric vehicles. Thank you very much for joining me today, John.
Rosevear: Thank you!
Priestley: That's it from us today. If you would like to get in touch, please feel free to email us at firstname.lastname@example.org, or tweet us on Twitter @MFIndustryFocus. As always, people on the program may own companies discussed on the show, and The Motley Fool may have formal recommendations for or against stocks mentioned, so don't buy or sell anything based solely on what you hear. For John, I'm Sarah Priestley. Thanks for listening and Fool on!
John Rosevear owns shares of Ford and General Motors. Sarah Priestley has no position in any of the stocks mentioned. The Motley Fool owns shares of and recommends Ford, Nvidia, Tesla, and Twitter. The Motley Fool has a disclosure policy.