Are Car Incentives Making A Comeback?

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 |  Includes: F, GM, HMC, TM
by: Jacob Steinberg

As 2013 was a hot year for the car companies in North America, the entire industry faced strong demand across the board and almost every car company operating in the continent was able to either eliminate or greatly reduce their incentive programs. As a result, margins were improved greatly across the board, and we saw almost every car company reward their shareholders greatly during the year. Now, many car companies have big inventories and they are trying to get rid of some of their inventories by offering incentives. We can say that incentives are making a comeback, for the time being.

Reportedly, Ford (NYSE:F), GM (NYSE:GM) and Chrysler all have dealership inventories worth of 100 days and these companies are offering incentives and some other discounts in order to move their inventory, particularly their trucks before spring comes.

GM's Presidents Day sale has become a tradition in the recent years. This year, many dealerships will partake in an incentive program where incentives up to $7,092 on the 2014 Chevrolet Silverado and up to $7,588 on the 2014 GMC Sierra are being offered to customers that are willing to take one of these vehicles home with them. Ford's F-series pickup trucks come with an incentive of $3,250, and some of the dealerships are offering even bigger discounts and incentives for the buyers in addition to this amount. Bloomberg reports:

On its website on Saturday, Mac Haik Ford in Georgetown, Texas, was selling a 2014 F-150 XLT for $36,315 - a discount of $8,790 from the suggested retail price of $45,105. At Marysville Ford in Washington state, a similar 2014 F-150 XLT was being offered for $8,360 off the $39,355 sticker price.

Pickup trucks are the biggest profit-makers for American car companies. In fact, in many cases, a pickup truck will claim 3 to 5 times as much profit as a sedan or a compact car sold in the same market. Furthermore, pickup trucks and SUVs jointly claim two thirds of pre-tax profits for these car companies. Currently Ford enjoys a four-month supply of F-150s, and GM enjoys a five-month supply of Silverados. The two companies recently blamed the winter weather for the recent weakness in their sales. If the inventories for these companies continue staying high, we might see more incentives. In the next few weeks, if inventories at dealerships start declining, this will be a good indicator for stronger demand.

Incentives were not limited to pickup trucks either. When we compare the December 2013 incentives with the incentives offered by the car companies in December of 2012, we see that almost every car company ended up increasing their incentives compared to 2012. On average, car companies increased their incentives by 4% compared to 2012 where average incentive jumped from $2,573 to $2,676. The biggest incentive increases came from Ford (21.7%, up from $2,749 to $3,346), Hyundai/Kia (17.9%, up from $1,477 to $1,741) and Honda (NYSE:HMC) (14.8%, up from $1,657 to $1,902). The only company with an incentive decline was Chrysler that reduced its average incentive from $3,262 to $2,954, a decrease of 9.4%. While Nissan and Volkswagen increased their incentives by around 8%, Toyota (NYSE:TM) and GM increased their incentives by 3.2% and 3.8% respectively. On month-to-month basis, average incentive increased by 0.5% as Nissan, Ford and Toyota saw declines and GM and Chrysler saw the biggest increases.

An increase of incentives doesn't necessarily mean that demand is weakening. The average car in the US is still around 11 years, and many people still need to replace their cars with newer ones. We might be seeing a temporary decline or slowdown in demand due to external factors such as the harsh weather. The issue with high inventory numbers might also be signaling excessive production. We will not really know what the issue is for another few months, because it takes a while to build statistical trends and pinpoint the reasoning behind them.

By offering incentives, the auto industry can reduce their inventory to healthier levels, move more vehicles and offset some of the effects of the recent interest rate increases for the customers. On the other hand, offering incentives will result in weaker profit margins across the board.

Incentives are not unique to North America either. In Europe, aggressive incentives helped with reversing a two-year trend to increase unit volume in several countries. Compared to the North American market, the European market proved to be a much weaker and more challenging market for the auto industry. I am almost certain that the carmakers will continue to offer generous incentives in the continent of Europe, and this was already expected by the investors. On the other hand, many investors didn't really expect to see incentives making a strong comeback in the North American market, as this market was known to be particularly strong in the last year and half. The investors should probably keep an eye on the level of incentives in the North American car market in the coming weeks and months. Once more data becomes available, we will know whether the issue is temporary or here to stay.

Disclosure: I am long F. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.