After five years of strong growth it appears the US auto cycle has peaked. I wrote an article a few months ago outlining the bear case for the US auto industry, and sales have started to fall off for most manufacturers in the past month or so. Sales fell more than 8% in August for Ford (NYSE:F), and according to Autodata, sector-wide light vehicle unit volumes declined 4.2%. This has important implications for Sirius XM (NASDAQ:SIRI), a company for which new car sales are a major revenue driver. A Wunderlich analyst thinks the fears are overblown, and that shares of SIRI are underpricing the company's growth potential. We urge caution, as there are some issues with the analyst's logic, and note that the risks to SIRI extend beyond auto industry cyclicality.
Despite the headwind from declining auto sales, the analyst believes SIRI is "well positioned for growth in in-car entertainment". He forecasts light vehicle sales of 17.5 million in 2020, flat from 2015 levels, and thinks that sales of used cars will offset the demand weakness from lower new car sales. The analysts estimates that SIRI will 1.4 million net subscribers annually and achieve 2.1% ARPU growth, compared to the 1.2 million and 1.8% million growth that is currently embedded in the stock price. SIRI posted strong results in its most recent quarter, growing subscribers 8% y/y and total subscriber revenue 10%. Management raised its full year guidance, and now expects to add 1.7 million net new subscribers (up from 1.6 million prior).
But we have some issues with the analyst's thesis, and don't think that the latest quarter was an accurate indicator of things to come. The problem is that an increasing portion of demand coming from used rather than new-car sales will likely lead to higher churn and slower net subscriber growth. This is because customers who purchase used cars have less wealth and are more sensitive to price (and less likely to subscribe to SIRI). It is therefore unwise to assume that SIRI will retain all its customers from used car transactions in which the prior owner already had Sirius XM installed in his/her vehicle. In its annual report, SIRI acknowledges that this is a risk factor:
"Our work to acquire subscribers purchasing or leasing pre-owned vehicles may attract subscribers of more limited economic means…We cannot predict how successful we will be at retaining customers who purchase or lease vehicles that include a subscription to our satellite radio service." - 10K 2015: Risk Factors
It is also important to keep in mind that there is a lag between the sale of a new car and when SIRI recognizes revenues from new subscriptions. Auto industry sales only recent started to decline, and the company's strong performance in Q2 undoubtedly reflected demand that stemmed from new car sales throughout 2015. Investors shouldn't expect SIRI to report weak sub figures until next year, at which point some time will have elapsed since auto sales peaked.
The risks to SIRI extend beyond the auto industry. First, we think the US economy is getting weaker, and that sluggish discretionary income growth will be a headwind for the company. Consumers will find it more and more difficult to justify paying for satellite radio, especially when so many alternatives are available for free. And this brings us to our next point. Competition from other forms of digital entertainment will only increase over the next five years, and we worry that satellite radio is slowly becoming obsolete. Consumers can access most (if not all) of the same content (through apps, YouTube, podcasts, and other sources) on their smartphones, and usually at much lower cost (if not for free). The moat around satellite radio has decreased significantly, and digital and internet-based competition will only increase going forward.
SIRI is priced for growth and investors should be weary of a number of headwinds that will prevent the company from growing at the same rate as in years past. A downturn in the auto industry is the latest challenge, and a growing portion of price-sensitive consumers in the auto sales mix will likely lead to higher churn. Don't be fooled by the strong numbers that SIRI will continue to post throughout the year, as they reflect demand from last year's strong auto industry performance. Not until 2017 will the recent weakness in autos become apparent in SIRI's results.
Disclosure: I/we 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.