It's Not Just Sales Anymore

If U.S. light-vehicle sales for August are any indication, investors might get comfortable again with the auto industry.

Spurred by Cash for Clunkers incentives, August sales of 1.2 million units broke the 1-million mark for the first time in 12 months, boosting the seasonably adjusted annual rate to 14 million.

That follows a “relatively stable” retail SAAR since October of last year, ranging from a low of 7.6 million units in April to a previous high of 9.1 million in July, says Himanshu Patel, a senior auto analyst for JP Morgan Securities.

It raises three questions, he says. “Is the stabilizing a fluke? What is ‘normal’ SAAR? What's the timing of recovery.”

For investors to reach a “normalized buy side” these days, the SAAR must reach 12 million in North America and 17 million in Europe, says Patel.

He bases that on ongoing conversations with 200 equity investors he regularly deals with. It's all relative though.

“Two years ago, a bad SAAR was considered 14 million,” Patel says at the Society of Automotive Analysts' 2009 Strategy Planning Summit in Troy, MI.

Currently, investors are looking at the auto industry two years out, as the nation shows early signs of slowly emerging from a recession.

“People understand a recovery is coming, so no one is really focused much on 2009 or 2010,” Patel says. “But if you don't see signs of a normalized recovery by 2010, these stocks will go down.”

Vehicle sales and the unemployment rate are inextricably linked, but, ironically, trends show falling auto sales historically precede rising unemployment by a few months, rather than the other way around.

“It's not so much a case of not buying a car because you lost your job,” Patel explains. “It's a question of not buying a car because you fear you're going to lose your job.”

He adds: “Consumers usually don't buy cars just to replace cars. They buy when they feel rich. They don't buy when they feel poor. It's a measurement of wealth.”

Before the auto industry went south last year, investors, many rattled and some burned by recent events, looked principally at the SAAR in placing bets.

Now they look at other financial factors and study the entire structure of a company, whether it is an auto maker, supplier or publicly owned dealership chain.

“Before, investors were looking at sales,” Patel says. “Now, they are looking at leverage, refinancing risk and covenant issues.” Problems in those areas — such as a company being excessively leveraged — are “looked at more suspiciously.”

Looking at the whole picture is important to equity investors because “they are the last guys to get paid,” Patel says.

Government bailout and stimulus plans that aided the auto industry had the added benefit of quelling investors' worst-case fears, Patel says. The government to the rescue in the U.S. and elsewhere “took the Armageddon factor off the table.”

Massive dealership eliminations emerged as a controversial part of GM and Chrysler restructuring.

“Despite the drama in the media of dealers being mistreated, I'd argue that the cuts were necessary and done in a rational way,” Patel says. “The dealers that are left will be more profitable, invest more in their stores and in training and have a better-motivated sales staff.”

Whether the dealership reductions will save auto companies lots of money “is not an easy question,” he says. “There is not an immediate savings. But long term, it improves dealers' profits, which should lead to better service to customers, which should lead to higher sales.”

Large publicly owned dealership groups, in particular, benefited from the dealership reduction, even though some of them lost stores in the process.

The so-called “dealership-rationalization plan” to close thousands of stores shows support of “big and professionally managed” dealerships that survive, Patel says.