Light Vehicle Pricing To Become More Aggressive In 2007?

My thoughts on January U.S. light vehicle sales (automakers report Thursday afternoon) - conflicting signs but I think pricing becomes more aggressive as we move into 2007.

It snowed in Malibu California in January. Malibu! And the cold weather seemed to work its way east (even causing it to be a rather frigid 50 degrees at times this week in Florida). The cold and snow may be good for repair shop business, but it usually is not helpful in selling cars and thus helping dealers bring their inventories down.

To boot, January represents the toughest "comp" month of the year. January 2006 unit sales were up 7.5% (year over year), the biggest year over year increase of any month in 2006 (and six of the months in 2006 had year-over-year declines).

True, January is a rather unimportant month and can be subject to a lot of noise. Over the last 5-years January has only accounted for ~6.6% of annual unit volumes (based on the Ward's and BEA data), which is well below 8.3% (what 1/12 equals, or if vehicle sales were divided evenly throughout the year). So we need to be careful when we look at January as being indicative of anything. Because it is one of the least important months of the year and subject to significant swings from weather and "payback" from December year end blowouts.

For those of you that read me regularly, you are probably wondering why I am going into "comps" and weather anyway? Two areas that I usually shy away from when discussing vehicle sales trends (as most of the time I am trying to focus your attention on the inventories).

The reason is because despite all of the apparent headwinds (weather, tough comps), early indications suggest January sales turned out rather respectable. The Associated Press reported yesterday afternoon that Edmunds.com is forecasting 1.2 million units in the month of January. If achieved, it would be about 1% higher than last years "tough comp," and even a bit better than my forecast of 1.15 million units (a 0.6% increase).

I guess I can live with a respectable sales pattern for January (despite the above mentioned headwinds). But I would expect it to come from automakers becoming more aggressive in the pricing arena. So it perplexed me when I read an Auto News article on January 25, 2007 titled "GM will aggressively cut daily rental fleet sales in '07." Sure, we all know General Motors (GM) plans to lower its rental volumes. But what was interesting was Paul Ballew (GM's director of global market and industry analysis) comment in the article that "GM's incentive spending by midmonth January is 'down significantly' compared with the year-ago period."

And this is what becomes rather strange (in my book). In this (tug of war) world of excess supply creating demand, I find it difficult to imagine an environment where industry participants (particularly the biggest one) could be getting net price improvements and demand holding up fairly well (especially against some headwinds).

I have no hypothesis. No explanation. I can only say that something doesn't seem to add up. Keep in mind, as I indicated above, January is an odd month, so it very well could just be "noise" in the data. However, I think the pricing environment is likely to become more aggressive in the coming months as automakers fight for every ounce of share and respond to the dealer pushback from excessive inventories. Simply put, I think my forecast for 16.4 million light U.S. vehicle sales may end up proving soft this year. In fact, I think there is a good chance industry volumes end 2007 higher than 2006. But it will come at the expense of net price.

The plants need to keep cranking (well until hopefully the union negotiations allow for more capacity rationalization). And dealer inventories (as encouraging as 4Q's unweighted 2% year over year decline was) still need to move lower. Even with a nearly 1% increase in vehicle sales, I estimate dealers will end January with nearly 3.6 million units (which on a days supply basis equates to 81 days!).

I still believe higher rent, higher floor plan interest expense (due to higher rates), and squeezed profit margins (throughout much of 2006) have once again left dealers cautious in their ordering quantities (and why you see the domestic automaker production plans calling for such dramatic year over year declines). Something needs to get the dealers comfortable ordering (so the plants can start producing again). And in the past, this has historically been driven by some innovative pricing/promotion (i.e. 0%, employee discount pricing, etc.).

Maybe the world has changed, and January is the first of many "anomalies" I come out saying "I can't explain" (I'm not afraid to admit if I don't understand something in the data). But if the past (and more importantly OE economics) are any indication of things to come, I suspect we are headed for more aggressive pricing in the coming months.