The second significant announcement from our coverage group came when Midas announced that its fourth quarter SSS for U.S. franchisees were down 4 percent due to overall weakness in consumer spending. Apart from conversations with several of our private company contacts that indicate stable business overall, we have little evidence to support that the aftermarket is poised for a comeback in 2008.
The first quarter is again off to a slow start, and we would expect the group to provide a more conservative earnings outlook when guidance is provided. Recall that gasoline prices are higher this year than last year, which doesn't help consumer spending on automotive repair and maintenance heading into the first quarter.While we don't believe the automotive aftermarket is in a worse situation this year than last, we think the mindset of the consumer has been conditioned to one of "deferral," and that may continue to plague the industry for some time. Although we think deferrals have played a role in softer-than-expected demand, we also think parts longevity is extending the useful cycle, allowing the consumer to further defer automotive services.
Historically, the automotive aftermarket has been insulated from macro swings, as demand for automotive repair is more contingent upon parts failure than disposable income levels. But it appears that this trend recently has begun to alter course.In order to get a better gauge for the impact of higher gasoline prices, we calculated average household expenditures on gasoline. Using total miles driven (as provided by the Federal Highway Administration), total light vehicle registrations, average mpg levels for light vehicles (based on state fuel tax records) and fuel prices per gallon, we were able to derive average annual gasoline expenditures per light vehicle.
Then, by backing into the average number of light vehicles per household (function of total licensed drivers, average licensed drivers per household and average light vehicles per licensed driver), we computed the average annual gasoline expenditures per household. When this is compared to the median household income over the past decade, the results are staggering. From 1996 until 2002, gasoline expenditures averaged 3.6 percent of household income. Starting in 2003, that proportion began to increase (see Figure 1) to 4.3 percent in 2003, 5.1 percent in 2004, 6 percent in 2005, 6.6 percent in 2006 and 7 percent in 2007.
The 340 bps shift that occurred between 2002 and 2007 represents $1,650 per year on our estimate of a 2007 median household income of $49,000. Therefore, as a result of the continued elevation in gas prices (and the elevated proportion of gasoline expenditures as a percentage of household income), it's not difficult to understand why the aftermarket has witnessed such a deferral mindset among motorists, and why this has created such a challenging operating environment for our sector overall.
We believe that gas prices began to impact SSS performance for both retailers and service chains in 2005, when gas prices hit $2.50 per gallon. Household gasoline expenditures began to represent north of 6 percent of the median household income, and the deferral mentality began to take hold. From third quarter 2006 onward, we believe that the flat to plus-2 percent SSS results for retailers and professional installers represent the critical maintenance/parts demand of the automotive aftermarket. This run rate should be sustainable regardless of elevation in gas prices.
Is there any potential for acceleration in 2008? From a sales standpoint, most companies now face years of easy SSS comparisons, so we don't expect a material surge in demand or acceleration in aftermarket trends in 2008. This is especially true given the current economic challenges and higher gasoline prices. That said, we think that if the U.S. economy falls into a moderate downturn and a recessionary environment gains hold, we could see a retreat in petroleum prices as end-user demand wanes.
If gas prices recede from the $3 level to the $2 mark, we think aftermarket SSS could move from the current range of flat to plus-2 percent into the mid- to high-single digits. In times of economic difficulty, we expect a weakening in new car sales, when motorists hold on to cars longer, the aftermarket should have additional looks at incremental service and repair.
Save for a material downward move in the price of gasoline, we think 2008 will play out much like 2007. In our opinion, 2006 and 2007 were lost years in terms of growth, but the automotive aftermarket does offer relative shelter among consumer names given the more defensive nature of auto repair. Given the recent sell-off in many of our covered stocks, we believe investors are likely to find some attractive investment opportunities at current prices.
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, the nation's 14th-largest financial holding company with $130.8 billion in assets.
Disclosures: BB&T Capital Markets makes a market in the securities of O'Reilly Automotive Inc. BB&T Capital Markets expects to receive or intends to seek compensation for investment banking services from Midas, Inc. and O'Reilly Automotive Inc. in the next three months. Midas, Inc. is, or during the past 12 months was, a client of BB&T Capital Markets, which provided non-investment banking, securities-related services to, and received compensation from, Midas, Inc. for such services. An affiliate of BB&T Capital Markets received compensation from O'Reilly Automotive Inc. for products or services other than investment banking services during the past 12 months.
