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A resilient industry, but how long can the party last?

Monday, July 18, 2011 - 00:00

In an industry note we published in early April, we highlighted our concerns that the spike in gasoline prices from $3 at the end of 2010 to $3.70 in mid-April would lead to a slowing in miles driven as well as compression in consumer spending on automotive maintenance and repair. Industry channel checks confirmed our suspicions and were later validated by the 1.3 percent yr/yr miles driven decline in March and 2.4 percent yr/yr in April. While miles driven data is likely to show declines in May (when gasoline prices peaked at $3.97 per gallon) and perhaps through June, it appears that business trends began to stabilize into the latter portion of May and have continued strengthening through early July. At this point, stability in crude oil and gasoline prices is absolutely critical, in our opinion, to calendar Q3 and Q4 aftermarket sales performance, particularly as many of our covered companies will be cycling their most challenging comparisons from 2010.

Looking at the broader automotive industry, Q2 2011 has been a time of great turmoil, owing largely to supply chain and production disruptions stemming from the tragedies in Japan. After running at a 13 million annualized pace through the first four months of 2011, U.S. new light vehicle sales fell to 11.8 million units in May. In June, the seasonally adjusted annual sales rate fell further to 11.4 million units, declining sequentially and coming in below analyst estimates. Some disruption to May sales was expected as a result of inventory shortages, particularly of Japanese nameplate vehicles, with the magnitude of the impact expected to moderate over time. But how, then, do we explain the decline in June? A number of industry experts and auto analysts have attributed the continued weakness and sequential decline to further supply chain disruptions and other one-off items, including elevated fuel prices.

While June U.S. light vehicle inventories days’ supply at 54 was below the long-term historical norm of 60 days, we would note that this was 1) an uptick in supply from 49 days in May and 2) roughly in line with supply levels seen in Q1 2011, where light vehicle sales ran at an average rate of 13 million on an annualized basis. With respect to the potential impact of elevated gasoline prices, we would note that historically, the level of gasoline prices has shown minimal correlation with the absolute level of new vehicle sales. Rather, gasoline prices (as represented by the ratio of fuel expenditures to disposable income) have trended far more closely with the mix of new vehicle sales (as represented by passenger cars versus light trucks), which makes sense intuitively given the fuel efficiency advantage of passenger cars relative to light trucks.

In our opinion, the still depressed level of U.S. new vehicle sales is a function of the still tenuous economic “recovery,” including subdued levels of employment and income gains as well as continued consumer retrenchment and deleveraging. While corporate profits (and margins) are at record highs, the labor force participation rate is at lows not seen since the recession of 1981-1982, and with public sector layoffs likely to accelerate into the second half of 2011, it would seem that private sector hiring will need to pick up meaningfully from June levels (+57k private sector, -39k government, net nonfarm payroll gain of +18k) in order to maintain a slow claw back in the aggregate number of employed individuals. As such, until we gain comfort that the pace of payroll additions is likely to accelerate (and in a sustainable manner) and home prices are likely to stabilize and gradually recover, we do not foresee a meaningful pick-up in U.S. light vehicle sales. Against this backdrop, we believe that the U.S. motor vehicle parc will continue to age, yielding increased demand for automotive replacement parts and services, with trailing five-year new vehicle sales unlikely to bottom before mid 2013.

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