Tom Webb's Blog (Manheim Consulting)

Vehicle Miles of Travel: The long road back (updated)

This is an update to a post first made 12/5/11.  As expected, vehicle miles of travel (VMT) declined again in November.  The importance of this statistic to the automotive industry is simple - "vehilce miles of travel" is another way of saying "vehicle consumption".  As noted in the post on the aging of the vehicle stock, vehicles today simply last longer.  They will last a lot longer if they just sit in the garage.

Report details show that the smallest declines in VMT occurred on urban interstate roads.  The biggest declines were for rural roads.

Total vehicle miles of travel (VMT) are still be below the peak reached four years earlier.  Current statistics (updated through November) show a 2.6% decline from the November 2007 record.  And, in recent months, we have been moving further away from the peak; not towards it.

The decline in VMT is greater (and its recovery slower) than either the past recession or higher gas prices would suggest.  The pattern in VMT is, however, in tune with the falloff in employment, which peaked approximately the same time as employment (January 2008 versus November 2007).  With respect to employment, we are even further away from the previous peak (-4.4%).

As with employment, we suspect there are secular, as well as cyclical forces, preventing a quick return to the previous peak.  Shifts in demographics, housing patterns, and working environments have all reduced needed miles of travel.  And, of course, the weak economy continues to restrain discretionary travel.

And consider the recent report that teenagers are less apt to run out and get their driver license the first day they are legally able.  In 1985, 87% of all 19 year olds had a driver license.  By 2008, that percentage had a fallen to 75% - and that was before the recession, which so decimated teenage employment.  In a reversal of phrase, Michael Sivak, of the University of Michigan Transportation Research Institute, said, “…some young people feel that driving interferes with texting…”   

Does an Aging Fleet Equate to Pent-up Demand?

In 2011, the average age of cars and light duty trucks in operation reached a record 10.8 years, according to Polk.  It’s an interesting statistic with implications for new vehicle sales, but it is wrong to consider this simple aging of the fleet as some sort of quantification of pent-up demand.  There is no relationship between the average age of vehicles in operation and future new vehicle sales – either statistically, or theoretically, speaking.

As for the statistics, note that the vehicle parc has aged steadily for decades.  The average age was 6.5 years in 1975, 7.7 years in 1985, 8.4 years in 1995, and 9.5 in 2005.  Those earlier numbers would now be considered a “young” fleet, but that did not stop new vehicle sales from reaching new highs each decade.  Conversely, the average age of the fleet first hit the double-digit mark on July 1^st, 2008.  That did not even mitigate, much less stop, the subsequent plunge in new vehicle sales.

The aging of the fleet is as much engineering-driven, as economics-driven.  Vehicles today simply last longer.  And, with multi-vehicle households, individual vehicles do not rack up miles as fast as they use to.  For example, yours truly owns a 13-year old Chevrolet pickup.  It is not the primary vehicle in the household, but it is more than capable of serving its specific purpose.  And I expect it will continue to do so for many more years.  In no way does this truck represent pent-up demand for a new one, as it will be replaced with a used one.

And that is where we also find the underlying theory wanting.  Much of the increase in the average age of the vehicle parc is a result of the growing share accounted for by very old units.  (In other words, the average age has risen more than the median age)  After 15 years of use, less than 29% of the 1970 model-year vehicles sold were still on the road.  For 1990 model-year vehicles, that percentage rose to 60%.

Pent-up demand for new vehicles comes from vehicles 3 to 6-years old, not those over 10 years old.  And the number of 3 to 6-year-old vehicles in operation will hit a cyclical trough this year.  The older vehicles only have second-order derivative effects in creating new vehicle demand as, for example, the 10-year-old vehicle is traded for a 6-year-old one, and that owner then trades for a 3-year-old one, and that owner then trades for a new one.  We see that effect through used vehicle valuations, and there is no doubt that the run up in wholesale used vehicle prices has been, and will continue to be, beneficial to new vehicle sales.  

But for now, let’s just stick with the mathematically unchallengeable: “new vehicle sales influence the age of vehicles in operation.”  The reverse statement is much less certain.

Future VIO Growth: Slower and More Predictable

The growth rate of vehicles in operation (VIO) declined precipitously during the recession.  In fact, in 2009, vehicle scrappage exceeded new vehicle sales and, thus, there was a decline in the vehicle parc – a post World War II first.  With the improvement in the economy and new vehicle sales, the VIO count has once again begun to rise, but at an annualized pace (below two million) that is far short of the six-plus million annual growth rate posted in 2004, 2005, and 2006.

To assess what part of the slowing in VIO growth is a result of current economic conditions as opposed to longer term changes in demographics and lifestyles, it is useful to segment the growth into root causes.  In the simplest of terms, increases in VIO can be the result of either:

• growth in the number of households,
• growth in the number of households owning a vehicle, or
• growth in the number of vehicles per household.

Given time series for the number of U.S. households, the percentage of households owing at least one vehicle, and the average number of vehicles per household, we can mathematically segment VIO growth into one of the three root causes.  (Technically, there is also the synergistic effect between individual factors, but that can be simply prorated back to one of the three.)

This is what the analysis looks like for the past six decades:

 

Naturally, the share accounted for by an increase in the percentage of households owning a vehicle became miniscule after vehicle ownership became almost ubiquitous.  We also see a general decline in the share accounted for by an increase in the number of vehicles per household.  This was also a reflection of saturation as the number of vehicles per household rapidly approached the number of persons per household - and often exceeded the number of driver licenses at that residence.

In the last decade, there was a slight decline in the share accounted for by simple growth in the number of households.  This was a result of slowing household formation rates as economic conditions produced more “doubling up”.  (When kids move back in with parents, or unrelated persons double up, they bring their vehicles with them.)

It is logically to assume that in coming decades VIO growth will be driven primarily by household formation rates alone.  This will make future increases in the vehicle population both more predictable and less rapid.  Slower VIO growth, coupled with the long-term decline in the scrappage rate, suggests that the underlying rate of demand for new vehicles is far below the 17 million annual sales rate that was achieved during the seven year period between 1999 and 2005.

 

End-of-Term Residuals: From Big Losses to Big Gains

The following statistics are from the Ford Credit Auto Lease Trust 2011-B prospectus filed with the SEC on October, 26, 2011.  These trends are reflective of the leasing industry as a whole, although Ford certainly had some swings which were greater in magnitude than the industry as a whole.  (The data reflects all Ford Credit leases written since 2002.)

End-of-term residuals: from big losses to big gains.  In 2008, Ford Credit experienced an average loss of $3,390 per end-of-term vehicle returned and sold.  In the first six months of this year, that flipped to its mirrored image – a gain of $3,445 per unit.

And, of course, the percentage of end-of-term units that were being returned was highest when the losses were the worst.  Specifically:

	Return Rate
2007	77.4%
2008	82.2%
2009	75.7%
2010	66.0%
6 mos. 2011	57.5%

The change in the return rate meant that Ford Credit sold 7% fewer end-of-term units in 2010 compared to 2008, even though actual terminations rose by 15%.

Losses were a result of the market, not subvention.  The spread between contract residuals and ALG projected residuals remained fairly constant throughout this period.  It was the ALG projected residuals that proved overly optimistic in 2008 and overly pessimistic in 2011.

Outlook: In 2012 and 2013 we expect that the average dollar gains at end-of-term will be smaller (as contract and ALG residuals move up), but we expect return rates will continue to fall.   

 

Narrowing Gross Margins: Should We Worry?

Now that Penske has reported we can update last week’s posting on the sales-weighted gain in used vehicle retail sales achieved by the seven publicly-traded dealership groups.  It was 4%, not the 3% originally noted, since Penske had a better than expected gain.

Nine consecutive quarterly gains is certainly good news, but some are troubled by the erosion in gross margins.  Depicted here is the trend in the sales-weighted retail gross margin for these 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 in the third quarter of 2011 were less than in the second quarter and less than a year-ago.  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 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.  Likewise, 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.

 

Same Store Used Retail Unit Sales Continue to Rise

Six of the seven publicly-traded dealership groups have now released third quarter earnings.  (Note: Penske will release on November 2^nd and we have shifted CarMax’s quarterly filing since they report on a fiscal quarter that end 8/31/11).

Based on those filings, these dealers will post a sales-weighted 3% increase in same-store used vehicle retail unit sales for the third quarter.  This is down from a 7.1% gain in the second quarter and double-digit gains in the five quarters preceding that - but after nine consecutive quarterly gains, the comps are getting tough!

These dealerships are also in acquisition mode again.  As such their absolute used unit retail sales volume in 2011 will get close to one million units.  

The Disconnect Between Consumer Confidence and Consumer Spending

Consumer confidence numbers released today by the Conference Board showed a significant decline in October.  Indeed, it moved the Index back to recession lows.  Couple this with European and U.S. debt issues, and we are setting up for a possible bleak holiday selling season.

Economists, however, generally discount consumer confidence measures as simply coincident indicators that add no predictive or explanatory power beyond that provided by hard statistics like jobs and income.  But when you see a disconnect like that shown below, something must be going on.  In this instance, the popular explanation is that high-income households, which account for the bulk of retail sales, have kept on spending and now account for an even larger share of total sales.

That explanation is partly true, and is confirmed by the performance of high-end retailers like Neiman Marcus and card issuers like American Express.  But there are two simpler explanations that are just as important.  First, the retail sales tally is indifferent as to whether the purchase is made with a paycheck, a welfare check, or food stamps.  In the latter two cases (which are a growing share) the buyer was probably not exuding confidence.

Additionally, there is probably more inflation hidden in the total retail sales than many expect.  Food consumed at home has risen 6.3% in cost over the past year, and gasoline is still up 33%.  There is also inflation in all types of medical services (another area where the consumer is often not the direct payer).  

All told, this was a concerning release.  It may not tell us much about future retail sales, but is does point to a level of consumer anxiety that politicians of all stripes will attempt to exploit – and, by doing so, will only instill more uncertainty.

New and Used Vehicle Prices & Overall Inflation

Today’s CPI release showed a 0.4% increase in August and a year-over-year gain of 3.8%.  That’s not good for an economy with so much slack in it.  Even core inflation (less food and energy) was up 2.0% over the past year – the fastest increase since November 2008. 

Food (which is, in fact, a “core” household purchase and accounts for a larger share of household expenditures as income declines) rose 4.6% year-over-year.  And, more telling, food consumed at home rose 6.0% in price, while the price of food purchases away from the home rose only 2.7%.  Prior to the recession, the cost of eating out was rising faster than the cost of eating at home.  Thus, although fancy restaurants may now be keeping a lid on their $45 entrees, that does precious little for households stretching to make their monthly used car payment.

And what about prices of those used vehicles?  They have risen 5.8% over the past year, according to the Used Vehicle CPI (versus a 4.1% increase in the Manheim Index).  The many inadequacies of the Used Vehicle CPI were noted in an earlier post (10/15/09), but what we are seeing now is primarily a reflection of the Used Vehicle CPI being based on a three-month moving average.  As such, it lags trends in the Manheim Index and should start to show smaller increases shortly. 

 

New vehicle prices, which were up 3.8% over the past year, will also show smaller increases as supplies return and more competitive pricing ensues in the fourth quarter.  Witness the pricing for the new Camry.

The increase in the New Vehicle CPI over the past two years has been faster than anytime since July 1995.  That explains much of the movement in used vehicle prices.  The graph below is explained in an earlier post (3/24/10).    

 

Changes in Mileage and Auction Volume by Price Tier

This is a promised add-on to the previous post that looked at changes in average mileage and auction volume by price tier.  The August year-to-date 2011 versus 2010 comparison showed a strong (and the expected) correlation between volume and pricing strength.  (The blue dots below are that same ones shown earlier.)  But, a comparison between 2010 and 2009 (the red dots) shows no relationship at all.

 

 The explanation is simple.  The two red dots depicting the largest loss in auction volume are accounted for by the two lowest price tiers.  Given the nature of the recent cycle in wholesale pricing, it is not surprising that older and lower-priced units were slower to participate in the rise.  Take out those two outliers from the 21 individual price tiers and the relationship between pricing strength and auction volumes becomes significant.  Take out the lowest four price tiers, and the linear relationship becomes very similar of that of 2011 versus 2010.

The results confirm what we have all experience in the auction industry.  After more than two-and-half years of rising values, the pricing increases have reached (and have become more evenly and rationally distributed across) all ages and price categories.  

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 those tiers.  Increases in average mileage for vehicles within a given tier means that prices are strengthening in that tier 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 (both in absolute and percentage terms) for several broad price tiers for the first eight months of this year versus the same period a year ago.  Each price group shows higher average mileage, or, in other words, stronger pricing.  The biggest increase in average mileage (or pricing strength) has been for vehicles in the $8,000 to $11,000 price range.  The smallest mileage gains occurred at the extremes of lower- and higher-priced units.

 

Recognize, however, that this shorthand method of equating how many more miles a dealer is willing to buy for a given price is not a perfect representation of pricing strength.  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 sale 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.  (Increases ranged from +3.3% to 31.4%.)

 

Despite the limitation of this type of analysis and the absence of other factors that impact price, the near perfect relationship between share volume and average mileage is confirmation of how restricted wholesale supplies are impacting price in today’s market.  (In subsequent postings we will look to see if, how, and why this relationship may have differed at other points in time.)