Manheim Conference Call Part 1: Rental Vehicles and the New Vehicle Market

On Tuesday, Manheim (the world's largest used vehicle auction company) hosted their quarterly conference call. Used vehicle (wholesale) auctions are where car dealers (new and used) and "fleet" vehicle companies (like car rental agencies) take their vehicles if they can not sell them on their lot (I'll have more on "fleet" in a few minutes).

Thomas Webb, the company's chief economist provided his usual candid commentary about the industry.

And with great excitement after sending you yet another "mini manifesto" about the industry on Tuesday, I thought I would surprise you yesterday morning by sending a simple, short summary of what I learned on the Manheim call.

Obviously that did not happen. Brevity is not my strong suit. But hopefully you find my analysis rich with insight (understanding) about the auto retail industry and stocks that you can not find anywhere else (that is the goal at least).

So instead of the short summary I started out with, I ended up with a three part series (well I have to admit I am still working on the last part). Today's piece focuses (as the highlights suggest) on the comments Mr. Webb provided about the new vehicle and rental market in the first quarter. Part 2 will address the used vehicle market. And part 3 is about Upstream, Midstream, and Downstream remarketing. I hope breaking it up into 3 parts makes it easier to digest.

Barring some major industry "event," I plan to give you part 2 tomorrow, and part 3 Monday. Right off the bat, I want to say that while today's piece may give you some interesting data and thoughts about the new vehicle market, the bottom line conclusion (as I open up with in today's quote) really should not be all that different from stuff you have read from me in the past. So if you want to skip today (for those loyal readers), I am cool with that. But you do not want to tune out tomorrow's piece on the used vehicle market.

You have heard me discuss in the past my concerns with the used vehicle industry data. Mr. Webb similarly raised this concern on the conference call Tuesday (as I discuss in part 2). But in tomorrow's piece I will also address WHY I think you are seeing such confusing data being reported. A piece I do not think you want to ignore.

Rental Vehicles
In the first quarter, vehicles sold into the rental market were down 12.7%.

Mr. Webb said: "GM (GM) was down 32%, Ford (F) down 34%, and Chrysler (DCX) was down only 1%. . . All told, the Big 3 accounted for just under 70% of all rental vehicle sales in the first quarter of 2007 versus 81% for all of 2006."

Now I followed up with Mr. Webb about the rental market decline, and he sent me the actual figures: 534,000 cars sold into the rental market in the first quarter of 2007 versus 612,000 cars sold into the rental market in the first quarter of 2006.

Let me put this into perspective for you. In the first quarter of 2007, there were roughly 3.87 million total new vehicles sold. That is down a bit (about 1%) from the 3.92 million new vehicles that were sold in the first quarter of 2006.

Now when I say total new vehicles sold, I mean the vehicles that you and I may have bought from the Ford or Toyota (TM) dealer down the street (retail). But I also mean the government vehicles the local police station may have bought for their officers to drive around and give us tickets with. Any company cars, sport utility vehicles or small (light) pickup trucks that may have been bought by business (commercial). And of course, all of the vehicles the rental car companies (like Hertz) buy from the new vehicle manufacturers (sometimes through dealers). I do not mean the big rig (heavy) trucks you see barreling down the highways (another several hundred thousand vehicles a year).

We call these (light) vehicles sold to government, business and rental car companies the "fleet" market. And generally, "fleet" sales account for somewhere between one out of every three to one out of every four (light) new vehicles sold in the United States every year. There are sometimes "definitional challenges" when you consider a doctor buying an Escalade for "professional purposes" and why I am giving you a somewhat big range (one out of every three to four) fleet vehicles per every new vehicle sold.

However, what every industry observer tends to agree on is that the vast majority of "fleet" units are the vehicles sold to the car rental companies (Hertz, Avis, Budget, etc). Industry experts like to call these vehicles sold to car rental companies "daily rent."

And it was clearly the "daily rent" figures that were down so much in the first quarter as the automakers (particularly the Big 3) attempt to focus on more profitable "fleet" (the business and government vehicle sales) and "retail" (you and me).

So when you take Mr. Webb's rental figures, and Ward's or the bureau of economic analysis (BEA) light new vehicle sales for the first quarter (how I end up with the 3.87 million total), what it tells us is that fewer than 14 out of every 100 new vehicles in the first quarter of 2007 were to daily rent versus slightly less than 16 out of every 100 new vehicles in the first quarter of 2006 being to daily rent.

And more importantly, if there really wasn't a very big decline in total light new vehicle sales in the first quarter of 2007 (remember only about 1% fewer than the first quarter of 2006), the number of vehicles you and I bought from that Ford or Toyota store (retail), probably wasn't very different and maybe even a little more than last year (in the first quarter).

The world (ok a lot of media headlines) is telling me how lousy the auto market is right now. But the figures I am seeing. When you think about the number of vehicles that you and I buy (retail?) The supposedly more profitable vehicle sales (retail) really aren't different from what they were last year.

Now maybe there is "pricing pressure" going on in the market making each new vehicle a dealer sells less profitable. And I think it is safe to conclude that we (investors and industry observers) never really appreciated how difficult things were last year in the new vehicle market (at the retail level) in the first quarter. But it begs the question: was the first quarter (2007) auto retail environment really as difficult as the media portrayed it to be? Dealer inventories were down year over year (suggesting dealer budgets were better aligned). Retail sales were flat to possibly up.

I am not trying to make a "call" that publicly traded franchised auto retailer first quarter results are going to blow away the estimates. I am simply saying that if they don't, I would sure like to understand what dynamic is occurring in the market that is causing dealers to struggle so much?

Mr. Webb was asked on the conference call specifically about the new and used vehicle selling environment. Here's what he had to say:

The new vehicle market
"That's the easier question." Mr. Webb said when asked about the new and used vehicle sales environment. In part 2 you'll understand why new vehicle sales are easier to address. He continued:

I think new vehicle sales will be down (year over year). Probably north of 16 million units, but not by much. Some of which will be facilitated by the fewer rental sales.

To put Mr. Webb's statements in perspective let me point out that in 2006 there were roughly 16.5 million new vehicles sold in the United States. Now earlier in the conference call Mr. Webb said he thinks "daily rent" volumes are likely to be down 6% to 9% for the year.

So when you take into consideration what I just talked about (above) with respect to the rental market, whether you believe Mr. Webb's "north of 16 million units, but not by much forecast), my forecast of 16.3 million light vehicles, or any of the automakers or public dealer management teams that all seem to be suggesting a low to mid 16 million light U.S. vehicle sales forecast, none of us are really (by default) saying we expect the number of vehicles you and I buy at retail to decline in a meaningful manner. You would need to be below 16.2 or 16.3 million units for any decline in retail to occur. And so until you start hearing a 15 million figure, an expert really is not calling for a meaningful drop in retail sales.

We (supposed industry experts and observers) for the most part are therefore expecting a reasonably healthy new vehicle selling environment. And why shouldn't we? Something like 95 out of every 100 people that want a job in the United States are employed (less than 5% unemployment rate where unemployment is determined by "job seekers.") The U.S. stock market is near record levels, and it is the "rich" that tend to be invested in the stock market and conveniently the majority of the people that buy NEW vehicles.

Now maybe people will begin to "feel" poorer over the next several months as they realize the value of their house isn't what they thought it was. Or maybe rising gas prices prove the impetus to cause folks to "tighten their belts" and buy fewer things (like cars) as two years of Americans spending more than they earn (the first time since the Great Depression) begins to catch up to them.

I still think weaker demand for new vehicles is inevitable sometime in the next 5 years simply because the market has become saturated (1.2 vehicles per licensed driver). The rich just don't need more. I am unaware of any economic cycle in the history of the United States that has been like the last ten years. In the early 2000s, the economy (as measured by "economic output" or "gross domestic product") slowed down and yet new vehicle sales (a highly discretionary purchase) remained near record levels. At some point the "demand creation" (incentive) game that created the stability will need to come to an end (in my opinion).

The question becomes can lower "manned capacity" allow the automakers to end the "demand creation" game? Or will it actually require fewer physical automotive manufacturing plants? As I have said before, this summer will be very telling.

But until we see signs of slower demand, I (and I think most industry observers) see little reason to go out on a limb and call for some dramatic drop in new vehicle demand.

The bottom line? The current call by most industry experts for slightly lower new vehicle sales in 2007 essentially is based on the expectation for fewer new vehicles being sold into the rental market. Unless you hear someone talking about a 15 million number, given the planned reductions in the rental market by the automakers, by default, these experts can not be expecting meaningfully weaker retail demand.

Tax refunds
Oh yeah, one interesting data point from the conference call that really doesn't fit into the series but interesting nonetheless:

"through March 31, 2007, the number of tax refunds are up 2.3%."

Tom Webb, citing data from the IRS.