Pent-Up Demand Bodes Well For Automakers

Includes: F, GM, TSLA
by: Feria Investor

The average age of cars and trucks on the roads these days is 11 years old, approaching record highs. Consumers have simply held off on replacing their vehicles over the last few years, as the depth of the recession proved to be too much for many to handle. Automakers are now citing this pent-up demand favorably, however, and this bodes well for companies like Tesla (NASDAQ:TSLA) and Ford (NYSE:F). Consumers are becoming more and more cash positive, and employed at a higher rate, and are generally more comfortable making a vehicle purchase.

Demand for Tesla's Model S is notoriously high compared to the available supply, as its Fremont, Calif., plant continues to churn out a few hundred models a week. Tesla's popularity happens to be coinciding with a broader macro-economic phenomenon that could continue for the foreseeable future. As these vehicles on the road age even longer, consumers will eventually stop pouring money into repairs and eventually spring for a new vehicle. And with oil prices this high, a car like the Model S could be exactly what a driver is looking for.

Ford CEO Alan Mulally predicted that the U.S. auto industry could sell up to 17 million units this year, and cited the Fusion midsize as creating so much demand that 1400 workers are to be hired for the Flat Rock, Mich., plant. The vehicles on the road are aging beyond their efficient use, and the demand will remain high as consumers begin to look around. Could Tesla follow the same trajectory, and take advantage of such high demand? We already know that the Model S is outselling a handful of major car brands in California, like Volvo and Cadillac, but what of its prospects outside the golden state?

Estimates of a 40,000 unit 2014 year will draw largely upon the U.S. market, doubling this year's production. But beyond, Tesla founder Elon Musk has intimated that additional plants will be required for other electric car vehicles Tesla plans in the future. Because Tesla wants these plants "close to where people are, close to where the customers are, to minimize the logistics costs of getting the car to them" Tesla will be establishing plants in Europe, Asia, and other parts of the U.S.

What this means, of course, is a large amount of sunken costs for Tesla. It will expand its production capabilities at a high cost, even as the Fremont plant ramps closer to its 500,000 vehicle capacity. This will hurt the free cash flow/cash on hand for Tesla, where it lags several other automakers. Tesla reported a negative $78 million free cash flow, a pretty stark contrast to a company like Ford, which reports a positive $4.48 billion number. Of course, Ford manufactures and sells many, many more cars than Tesla, so what does this comparison really tell us? As Tesla works on this element of its business and tries to get positive, the comparables are so far ahead of Tesla that small, incremental gains will be cheered as successes. Just as Ford got a nice pop on the news of expanded shifts at its Flat Rock plant, Tesla will certainly be viewed favorably as it announces expanded production.

How will the other automakers fair? The latest research may portend a forfeit of this pent-up demand by the U.S. automakers to foreign car companies. According to the latest American Consumer Satisfaction Index, the only domestics to clock in at above-average scale are Cadillac and GMC. The Index surveys recent purchases of 19 different automakers, and signaled two General Motors (NYSE:GM) namesakes, Buick and Chevy, have decreased the most compared with a year ago. The satisfaction index seeks to illuminate where purchasers may be going next, since approximately 50% of buyers go with the manufacturer of their previous vehicle.

Fortunately for GM, this trend has not been borne out by sales numbers. In July, GM deliveries led the domestic automakers at a 16% increase, with Honda and Toyota also showing strong growth. In fact, the auto industry is looking at the best year for sales since 2007, as the demand continues to boost sales. Although the Satisfaction Index may be a harbinger of what is to come for GM in the future, it continues to track strongly for great numbers this year.

Another threat to the positive outlook in the auto industry is the potential for higher interest rates to dampen demand. Consumers who may have been on the cusp of a new auto purchase may be turned off by the higher monthly payments they can expect to pay. Whether these rising rates affect sales numbers going forward will be answered with time, but as of now it appears that the pent-up demand for autos is trumping those concerns.

Automakers have performed well in 2013, as the demand remains strong and consumers have taken advantage of lower interest rates. As the age of the fleet of cars on the road continues to rise, the demand should remain strong. The car makers that can take advantage will be able to reap the benefits of the upgrading consumer. And if a driver already owns a model from a automaker, it should hope the driver is satisfied with it by the time he or she is ready for a new purchase.

Disclosure: I am long TSLA. 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.