Prices sparking volatility

Jan. 1, 2020
As we approach midyear, it seems like a lifetime ago that oil prices were hovering below $100 per barrel. True, the economic impact was being felt even then, but today's price levels are certainly unexpected and — many may argue — unjusti
As we approach midyear, it seems like a lifetime ago that oil prices were hovering below $100 per barrel. True, the economic impact was being felt even then, but today's price levels are certainly unexpected and — many may argue — unjustified. We think what may be more troubling to the market is not necessarily the actual level of oil prices, but rather the daily volatility. Large swings such as the $10 spike on June 6 are upsetting and exemplify underlying macroeconomic and geopolitical concerns.
Consumers are resilient and can adjust, but as volatility increases without stability in prices, we think the consumer in many ways becomes paralyzed. As shown in Figure 1, consumer sentiment (as gauged by the University of Michigan Surveys of Consumers) has come under pressure as oil futures have moved past the $100-per-barrel level and continue to exhibit significant trading volatility.

The preliminary June consumer sentiment reading was down 3.1 points from May and is the lowest level seen since May 1980 when the index reached 51.7. Looking at consumer sentiment over the past 18 months in relation to gasoline prices, the index reached a high of 96.9 in January 2007 and fell back to 75.5 in December. We expect that gasoline breaking the $4 per gallon mark in June has been a contributing factor behind the 28-year low in consumer sentiment.

Unfortunately, we may not receive a break in oil prices anytime soon, as the early start to summer has heightened fears of a severe hurricane season. We also think matters were made worse when the media (USA Today and the Wall Street Journal), for the first time that we can recall, ran articles on the decrease in miles driven in March.

The first indication that slowing economic growth and rising fuel prices were taking a toll on miles driven came in December, when VMT (vehicle miles traveled) declined 3.9 percent year over year. The rate of decline then slowed, moving into both January and February, when miles driven fell 1.7 percent and 0.4 percent, respectively. But then the March data was released,with VMT seeing the largest year-over-year decline since the energy crisis of the late '70s and early '80s.

In absolute terms, the 4.3 percent drop in March VMT represents a decline of almost 11 billion miles in travel. That may seem precipitous, but on a per-vehicle basis, that is only a decline of approximately 44 miles. We are not denying the fact that higher fuel prices are likely to put downward pressure on miles driven, but rather that it would take a sustained period of declining VMT (likely in the mid-high single digits) before the aftermarket witnessed a material decline in revenue.

We learned long ago that markets move on perceived risk even if the actual underlying fundamentals should not give cause for concern. So as not to sound too doom and gloom, we actually think the aftermarket as a whole has held up better than most would think, especially as we have seen gas prices climb.

As we write this article in mid-June, it appears that Wall Street is casting doubt on the ability of aftermarket companies to weather the storm and post results that are not deteriorating at an accelerating pace. While we are not so naïve as to think that the consumer is struggling mightily given the burden that higher gas prices have had on disposable income, our industry has dealt with economic headwinds since early 2006.

So, is the aftermarket immune to further deterioration in fundamentals? Probably not. It can also get worse, but we don't think the magnitude will be quite as severe as in some other consumer-oriented sectors. Discretionary spending on automotive services and repairs was eliminated over the course of the past two years, leaving the consumer with repair work that is much more critical in nature.

Perhaps evidence to support this was most recently reflected in Monro Muffler's quarterly results. Monro's comparable sales increased 8 percent in April, followed by 4.5 percent growth through mid-May. More meaningful to us is that traffic count for both months increased. We think improvement in April and May has been consistent, with the majority of companies optimistic that June may provide better than expected results. Also consistent is the outperformance in general for the DIFM (do-it-for-me) segment relative to the DIY segment.

To date, we have not heard of any real trend deceleration, and the high temperatures felt across most of the country should help summer categories such as temperature control.

Though it's hard to determine if these trends are sustainable given the tough macro backdrop, all-time-high gas prices and declining miles driven, we think the defensible nature of the automotive aftermarket is finally becoming evident. Deferrals are likely to continue, but simply can't be sustained indefinitely.

We also think the decline in new vehicle sales will create additional opportunities for automotive services. If the consumer is not purchasing a new car, we think there could be a spike in demand for services on the older fleet of vehicles. Does that mean robust comps are sustainable? Probably not, given $4 per gallon of gasoline, but it might indicate that even with elevated gas prices and declining miles driven, we won't see a deceleration in sales trends for the group.

BB&T Capital Markets is a full-service investment banking firm that focuses on specific industries, including the Automotive Aftermarket industry. BB&T Capital Markets is a division of Scott & Stringfellow, Inc., NYSE/SIPC. Scott & Stringfellow is a registered broker/dealer subsidiary of BB&T Corporation, one of the nation's largest financial holding companies with $136.4 billion in assets.

Disclosures: BB&T Capital Markets makes a market in the securities of Monro Muffler Brake, Inc. and O'Reilly Automotive Inc.

BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Advance Auto Parts, Inc.; AutoZone Inc.; Genuine Parts Company; Midas, Inc.; Monro Muffler Brake, Inc.; O'Reilly Automotive Inc.; Standard Motor Products, Inc.; and The Pep Boys—Manny, Moe & Jack in the next three months.

Advance Auto Parts, Inc.; Midas, Inc.; and Monroe Muffler Brake, Inc. are, or during the past 12 months were, clients of BB&T Capital Markets, which provided non investment banking, securities-related services to, and received compensation from, the aforementioned companies for such services. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report knows the foregoing facts.

An affiliate of BB&T Capital Markets received compensation from Advance Auto Parts, Inc.; AutoZone, Inc.; Genuine Parts Company; Monro Muffler Brake, Inc.; and O'Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months. The analyst or employees of BB&T Capital Markets with the ability to influence the substance of this report know or have reason to know the foregoing facts.

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