March Auto Sales: Headline Numbers Conceal Fundamental Weakness

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 |  Includes: F, GM
by: Dave Kranzler

Summary

Aggressive incentives drove month-end push for sales.

March had five full weekends.

Dealer inventory stuffing.

Proliferation of junk financing to stimulate sales.

The March auto sales report was released Monday. The headline- grabbing seasonally adjusted annualized rate of sales data showed a nice pick-up in auto sales during March vs. the first two months of the year. The report seemed to stimulate a big stock market rally. However, a detailed analysis of the non-adjusted, actual monthly data for March reveals fundamental weaknesses embedded in the sales trends that are not reflected by the headline numbers. In fact, it is my view that, absent the unsustainable factors which boosted sales in March to a level that was slightly higher than expected by analysts, auto sales going forward will likely fall well short of the sales projections for 2014.

While it is true that sales were up 6% for March 2014 vs March 2013, sales were up only 1% for all of Q1 2014 vs Q1 2013 (data link). It is likely that sales in March, compared to Jan/Feb this year, were driven by aggressive incentives which were implemented mid-month by the entire industry after sales in the first half of March were described as being slow. The automotive industry analytics firm ALG estimates that incentives in March were nearly 8% higher than in March 2013 and were up 2.6% from February - AutoNews.com.

Clearly, with heavy sales incentives applied in the second half of March, auto sales for the month were boosted from March having five full weekends. As the President of auto market data analytics firm ALG states: "incentives rose at a rate four-times greater than industry sales in March, forcing a final rush to discount in the last week of the month" (see link above). The fact of the matter is that, on the basis that heavy price discounting was used to stimulate sales, it is probable that a not insignificant amount of future sales were "pulled" into March. Thus, while the unit sales comps vs last March and last month look positive, the cost of this sales stimulus will be reflected in lower OEM profit margins this quarter and lower sales next quarter. If this is the cost of generating sales, I would argue that this reflects inherent weakness in the demand fundamentals of the market.

The second factor which likely drove the sales numbers was dealer inventory build-up, aka "channel stuffing." General Motors (NYSE:GM) is the most transparent with its dealer network inventory reports. At the end of March GM dealers had a record level of cars in their inventory: GM month-end dealer inventory. GM reported 256,047 unit sales in March. But 9,000 of that came from the inventory growth at its dealer network. If we subtract that 9,000 from GM's March sales report, GM's sales would have shown a slight decline from March 2013's sales level. Please note that GM's February month-end inventory was a record level until this month.

The rest of the auto industry is more opaque with dealer inventory numbers. However, a Ford analyst did disclose that Ford's dealer inventory was at 72 days vs. 62 days at the end of last March, a 16% increase in inventory level. While we can't quantify the affect on Ford's reported sales number like we can with GM, clearly Ford's level of reported sales benefited from channel-stuffing. Again, as with the application of aggressive price incentives, eventually channel-stuffing will lead to a lower relative level of future dealer orders, which will result in lower future sales.

The final factor which seems to be stimulating the level of auto sales is the increasing use of debt and, specifically, the proliferation of subprime "junk" debt. Equifax reported that at the end of December the amount of outstanding auto loans hit a post-2008 financial market crisis high of $859 billion. 34% of this was classified as subprime, with another 10% classified as deep-subprime (credit score below 550). Morgan Stanley's auto analyst wrote that "Perhaps more than any other factor, easing credit has been the key to the U.S. auto recovery" (Businessweek).

We also know from the latest consumer credit report from the Fed for January that auto loan issuance continued to rise. While we don't have the numbers for February or March, it is likely, given that a significant amount of the sales incentives discussed above are based on low interest/0% financing, that auto credit continued to fuel sales in March. The problem here is that auto loan delinquency rates are starting to rise again: Q4 2013 delinquency rates at highest level in a couple years. At some point the market's ability to absorb credit losses and willingness to fund subprime auto loans will be curtailed. Given that auto loans are fueling sales, this will obviously have a big impact on sales sooner or later.

Based on these factors discussed that I believe have artificially stimulated sales this year, especially during March, it is my view that the true demand for new automobiles is going to decline well below the current analyst sales projections for all of 2014. Because of this, I believe the OEM auto stocks are overvalued. I recommended shorting GM in early January when it was just above $40. That's a 13% gain on the short position. The S&P 500 is up 3.2% over the same time period. Ford (NYSE:F) has been up slightly but I'm not a fan of shorting low-dollar stocks like Ford. However, if the stock market ever goes into correction mode, I believe even bigger gains can be made shorting GM at its current level.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. 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.