Tom Webb's Blog (Manheim Consulting)

Ford Motor Credit Repos Fall in 1st Quarter, but 24-month Lease Returns Rise

These slides are from today's Ford Motor Company First Quarter Fixed Income Presentation:

 

Dealership Groups Post Another Strong Quarter in Used Vehicles

With today’s release from Asbury and Group 1, all seven of the publicly-traded dealership groups have now announced first quarter earnings.  Shown below is my calculation of their sales-weighted same-store used vehicle retail unit growth.

It was another strong quarter for used vehicle operations.  Same-store unit volumes rose 9%.  And, since it marked the eleventh consecutive quarterly increase, the comps are getting increasingly difficult to beat.

Gross margins narrowed from their year ago level. (They were up from the fourth quarter, but that is the normal seasonal pattern.)  As noted in an earlier post (2/29/12), part of the narrowing in gross margins has been willingly accepted by dealers as they attempt to retail out of units, rather than wholesale them.  In addition, as also noted in the earlier post, since the gross margin measure is sales-weighted, a shift in sales volume between the groups may distort the true trend since each company has historically different margins that are dependent on sales mix, geographic mix, and even accounting.

To appreciate the changing used vehicle sales strategies of individual dealer groups, consider:

• Average selling price – some of the dealership groups showed significant increases, reflecting higher wholesale prices.  Others showed little, or no, increase, which indicates they are now selling older, higher-mileage, units.
• Wholesaling percentages – the first quarter was a mixed bag: up for some dealership groups, down for others.
• SG&A expense as a percent of gross – there has been considerable improvement in recent years.  This is not only the result of higher volumes, but also increased efficiencies.

P.S.  As a sign of the times, and offering further support to future used vehicle values, new vehicle gross margins improved in the first quarter on a sales-weighted basis.  That’s pretty much a first.  

Vehicle Miles of Travel and Employment: when, if ever, will they return to previous peaks?

Total vehicle miles of travel (VMT) rose 1.8% in February versus the year-ago level.  As in previous months, the gain was concentrated in the Northeast and North Central regions.  VMT in both regions has been helped by mild winter weather and, in the latter region, by an economy that is performing much better than the overall U.S.

As noted in earlier posts, VMT and employment peaked at similar times (November 2007 for VMT, and January 2008 for employment).  The graph below tracks the percent change from the peak for each series.

Since VMT is expressed as a 12-month moving average (as opposed to employment’s monthly seasonally adjusted number), it shows less severe movements.  I fully expect employment will show a smaller percent decline than VMT in the near future.  What’s troubling, however, is that both series may pull back again before reaching the zero line (thus, my “upward-slanted W” theory for the recovery.)   

March’s VMT report should be telling as weather becomes a non-issue and the forces of higher gas prices and higher employment push in opposite directions.

New & Used Vehicle Pricing Support Each Other

Today’s Consumer Price Index release showed the new vehicle component rising 0.2% in March, and 2.5% over the past year.  (These prices are mix- and quality-adjusted and are net of incentives.)  March marked the twelfth consecutive month where the year-over-year increase was above 2%.

That stands in stark contrast to the period between 1997 and 2008 when the new vehicle component of the CPI was flat or declining.  This has been described in earlier posts and is shown in the updated graph below.

And, as is shown in another updated graph, new vehicle pricing goes a long way in explaining the continued rise in the Manheim Index.

P.S.  The used vehicle component of the CPI rose 1.3% in March, the biggest monthly increase since December 2009.  Earlier posts have noted the deficiencies in the measurement of the used vehicle CPI, but it too tracks with the new vehicle CPI.

 

Vehicle Miles of Travel: even with recent increases, far below peak

In January, total vehicle miles of travel (VMT) increased by 1.6%.  This came on the heels of a 1.3% rise in December.  That later gain, however, followed nine consecutive months of decline – and, the twelve-month rolling average of VMT is still 3.5% below the peak level reached in November 2007.

As was the case in December, the biggest VMT gains came in the Northeast and North Central sections of the country, which suggest that mild winter weather was partly responsible.

Previous posts have noted how the historic decline in VMT has exceeded what one would expect based solely on the recession and higher gas prices.  It has, however, been consistent with the failure of U.S. employment to also return to its previous peak (January 2008).

So, in addition to mild weather, recent monthly gains in VMT were likely aided by the 223,000 and 284,000 increases in employment that occurred in December and January.  In February, payrolls grew by another 227,000, but gasoline prices increased by nearly 30 cents a gallon and then another 20 cents, so far in March.  Thus, future VMT reports will give insights into how much structural change has occurred in consumer behavior.  The primary use of a vehicle is for travel to and from work, so if VMT remains weak even as employment grows it suggests a significant falloff in discretionary driving.  

Publicly-Traded Dealership Groups Enjoy Rising Used Unit Sales

With yesterday’s release from Sonic, all seven publicly-traded automotive retailers have now reported fourth quarter and full year 2011 results.  (Note: we have shifted CarMax’s quarterly filing forward by a month since they report on a fiscal quarter that ended 11/30/11.)

These dealers posted a sales-weighted 6% increase in same-store used vehicle retail unit sales during the fourth quarter of 2011.  This represented the tenth consecutive quarterly increase.  And these dealership groups are once again in acquisition mode, so their combined absolute used unit retail volume in 2012 will easily exceed one million units.  

Gross margins have, however, narrowed. Depicted here is the trend in the sales-weighted retail gross margin for the seven publicly-traded dealership groups.  A note of caution in interpreting: since this is a sales-weighted average, a shift in sales volume between the groups will distort the true trend since each company has historically different margins that are dependent on sales mix, geographic mix, and even accounting.

Nevertheless, there is no doubt that industry-wide across all franchised dealers that average retail used vehicle gross margins have declined in recent years.  The question is: how worrisome is this trend?  That depends on your theory as to the cause.  My belief is that most of the margin reduction is the result of rational business decisions – not desperation moves to move metal.

For example, there is no denying that more dealers are willing to retail out of their used inventory at a wholesale price rather than actually wholesale the unit.  The rationale is logical – earn doc fees, generate F&I income, allow salespeople at least some commission, create potential service revenue, and possibly garner a customer for life.

This was evidenced in the earnings releases.  Several groups showed rapidly rising used retail revenue, falling wholesale revenue, and stable or lower average used vehicle retail transaction prices despite the rise in overall used vehicle values.  Clearly, they were retailing older, less-expensive, units that they would have wholesaled in the past.  The higher unit volume and strong F&I income produced record used vehicle department net profits. 

In addition, more dealers are utilizing auction inventory as their own virtual inventory.  If you have already pre-sold a unit, a lower margin is acceptable since you have eliminated both holding costs and risk.

There is one major downside to this trend.  And dealers should be careful.  As the saying goes “gross is a state of mind”, thus, once you start doing low gross deals, you run the risk of all your deals becoming narrower.

Gas & Used Vehicle Prices Are Low (when measured in gold)

Once again the Pollyannaish among us are trotting out statistics that suggest we shouldn’t get alarmed about gas prices.  For example, on an inflation-adjusted basis gas is well below previous peaks.  Or, that a gallon of gasoline costs much less than a gallon of simple bottled water.  

As if that is any consolation to the involuntary part-time construction worker filling up his pickup truck!  Why not go to the extreme?  Look at the cost of gasoline relative to gold.  An ounce of gold will now buy twice as much gas as it did as recently as October 2008.  (That’s depicted below, with the vertical scale in reverse order.)

So if that construction worker happens to have a gold brick in the pickup bed, he’s just fine.  He can fill up the tank and then buy a whole fleet of nice used trucks.  Below is the dollar amount behind the Manheim Index (a mix-, mileage-, and seasonally adjusted measurement of wholesale prices) measured in gold.  

Vehicle Miles of Travel: no snow means we go

Monthly vehicle miles of travel (VMT) rose by 1.3% in December versus a year ago.  Attribute much of the rise to mild winter weather as evidenced by the biggest increases being reported in the North Central and Northeast regions. (http://www.fhwa.dot.gov/policyinformation/travel_monitoring/tvt.cfm).

Even with December’s gain, VMT for the full year was down 1.2%, and the twelve month rolling average was still 2.5% off the peak reached in November 2007.

A look at annual changes since 1973 shows that something more than a recession and gas prices is going on.  It’s a structural shift. (Additonal comments in 1/24/12 posting.)

The Yield Curve – A forever useless tool?

For more than half a century, the yield curve has been one of the more useful items in the economist’s toolbox.  An inverted yield curve (long-term yields lower than short-term yields) has predicted seven of the last eight recessions, with only one false positive.  A steep yield curve has often been correctly associated with forthcoming inflationary growth, but it has less predictive power than an inverted curve.

The Federal Reserve’s unprecedented policy actions, along with changes in communications strategy, have rendered the yield curve useless in providing insights into the current economic cycle.  For one, the tool’s calibration has been set askew by historically low interest rates.  Indeed, as noted in an earlier post, there were times recently when one couldn’t legitimately say whether the yield curve was becoming steeper or flatter.

To keep interest rates low and to flatten the yield curve the Federal Reserve did things such as changing its communication strategy (e.g., associating a specific time to what was previously known only as an “extended period of time”) and shifting holdings to longer-term maturities (e.g., “operation twist”).  But did the yield curve actually flatten?  It depends how you measure it.  Traditionally, analysts have looked at percentage point differences.  By that measure, the spread fell from a high of 2.8 points in February to 1.7 points today (which is still high).  But, with interest rates so low, the actual ratio between the yield on a 10-year note and a two-year note rose from 4.7 to 1 in February to 8.2 to 1 today.  And, more fundamentally, as succinctly described (along with an example) on the Econompicdata blog site (http://econompicdata.blogspot.com/2012/02/bond-101-duration-risk-at-zero-boundary.html) investors take on duration risk not only to achieve higher yields, but also for possible bond appreciation if rates fall.  Low rates today mean less room to fall, thus, less potential appreciation even though the yield curve is steep.

The Fed has clearly telegraphed that interest rates will remain very low for a very long time.  The most likely scenario is that the economy will enter a recession (even it is a long time from now) well before the yield curve inverts.  Thus, to answer the title question – yes, it has become a useless tool which will not give a heads up as to the next recession.

We may at some point long for the days when Fed policy was opaque and its communications enigmatic.  True, functioning markets – or at least ones you can make money in – require that participants have differing opinions as to the future.  The Federal Reserve policy actions have been removing uncertainty regarding interest rates, but increasing uncertainty as to the broader economy.   

   

                  

Real GDP & Auto Sales

With Friday’s release of real GDP we can now add another year to this interesting graph.  Each dot represents one of the 57 years between 1955 and 2011.  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.

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 .63 to .71 for the remaining 55 years plotted.  If we also ignore 2011, the R-square rises to .74.  As noted in the chart, 2011 was only time that an increase in real GDP of less than 2% was associated with a rise in new vehicle sales.

Strong cycles produce outliers, and after an outlier there is a movement closer to the regression line.  That will occur again this year, although I fully expect that the plot for 2012 will remain well above the regression line.

Also note that, in this comparison, 2009’s plunge in new vehicle sales (-21%) was not abnormal given the 3.5% decline in real GDP.  Indeed, it was almost right on the regression line.