There have been recent, relatively important developments in the mess that is the largest automotive recall in history: Takata airbags. In case you have not been following the event closely, here's a quick summary:
Takata (OTCPK:TKTDY) is a Japanese company that provides safety devices to car manufacturers: mainly airbags and seatbelts. In 2013, the first wave of airbag recalls were issued for about 3.6 million vehicles. The primary issue here is that the propellant used in the airbag inflator would deploy uncontrollably during a crash, which would then cause metal shrapnel to fly into the car's occupants. Over the past couple of years, this has resulted in fatal accidents. The recall has blown up on a global scale (over 100 million airbag inflators on recall and counting).
Needless to say, Takata is currently facing serious financial pressures - some say the liability figure for this recall is north of $10 billion. There have been 5 bidders for Takata, including their competitors: Sweden's Autoliv (NYSE:ALV) and Japan's Daicel (OTC:DACHF). I am not going to take a guess where Takata plans to take these bids. However, one thing is reported to be common among the bidders: They are all looking for Takata to file for bankruptcy protection.
How Takata's airbag recall has been handled so far
In short form, Takata filing for bankruptcy protection means that automakers and auto dealers will be eating the cost of the recalls. Whatever Takata's financial situation is, one thing is clear for both the automakers and auto dealers: The recalled items must be replaced.
The vehicles on the recall list go on what's called "stop sale" at the auto dealerships - the dealerships cannot sell these cars until the part is replaced. Just about every large automotive dealership has commented that the inflow of parts has been slow. For the auto dealerships, this recall affects floorplan financing, depreciation, and parts and service margin/shop hours.
Asbury Automotive (NYSE:ABG) CEO Craig Monaghan commented on some of their pain points:
These stores are being impacted when - like David mentioned in his script, when 40% of your inventory is on stop-sale, and we're just running out of space. They don't have cars to sell and, in some cases, we're looking for nearby lots in order to park these vehicles, so it has become very disruptive. But they are vehicles that, when we get the airbags, that we think are going to be very marketable. So we are holding on to them for the most part, and we're just going to ride this thing out.
Source: Q2 2016 Call
So as not to be taken out of context, Asbury does not have 40% of their inventory tied up in stop sale inventory, but certain locations have 40% of their used vehicle inventory tied up in stop sale. Overall, stop sale inventory accounts for 10% of used vehicle inventory.
Sonic Automotive's (NYSE:SAH) management team confirmed in their Q2 2016 call that many of the automakers are subsidizing floorplan and depreciation, but that Sonic does not get paid until the vehicles are fixed and sold. The parts and service revenue and margin on these airbags are not great either. Typically, for auto dealerships, gross profit from parts and service runs at about 40+ percent. The Takata airbag replacement work occupies valuable shop hours and Sonic management confirmed that automakers are not paying them a ton of money for it (33% ish gross profit).
The broader issue here is that these expenses are supposed to come out of Takata's pocket, and those pockets are empty. Judging by the dynamics of how the recall has been handled thus far (automakers subsidizing floorplan and depreciation while paying a seemingly reasonable amount for shop work), it looks like the automakers would be eating a larger share of the costs while the auto dealerships ride through a near-term cash flow headwind and downward parts and service margin pressure.
Investors with exposure to Autoliv or Daicel should start thinking about how much Takata's facilities and non-airbag operating business (assuming these don't have the same level of problems) is worth - and whether that justifies the bids reported. For those invested in automakers that are heavily exposed to Takata airbags - like Honda (NYSE:HMC) - you may want to take another look at the balance sheet and figure out whether the current price justifies what net damages are to come - seeing that the Takata airbag recalls seem to expand endlessly. As for those invested in auto dealerships, I would not worry too much about long-term damages considering the way the recall has been handled so far. Perhaps, there can be a wave of stop sale inventory being cleared, which might affect their sales mix while dragging their parts and service margins down.
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