The auto-loan-backed securities market is bubbling in a race for yield similar to the mortgage-backed securities market in 2006/2007.
Car sales have stagnated in the US since 2015, and since last year in China.
Europe is instituting new tough emissions standards that will crimp profits in the best case.
IMO 2020 even though it hasn't caused a serious oil price spike, will still be a negative for the auto industry all other things begin equal.
The auto sector is in trouble. Sales are stagnant to falling across the sector globally, new tough emissions standards are going into effect in Europe, and the financial plumbing of the auto industry is showing serious signs of repeating the same sickness that caused the housing collapse 13 years ago.
From MBS to ABS
Starting from the end, we have the subprime auto-loan-backed securities (ABS) market, which is showing the same symptoms of bubbling that the housing market did during its collapse in 2007. According to the Financial Times, in an article published late November, issuance of subprime auto ABS was at $29 billion for January through October, putting last year’s projected totals somewhere around $35 billion depending on the strength of the holiday season, eclipsing 2018’s record of $32 billion. This was despite sales declines of actual cars in 2019 over 2018.
The situation is reminiscent of the prices of securitized subprime home loans staying elevated for months following the collapse of the subprime loan market in 2007, simply because the ratings on those loans were not officially downgraded until the ratings agencies were forced to do so. Meanwhile, delinquency rates are on the rise as sales fall.
While 90-day delinquencies at least have not yet eclipsed the 2010 highs of 5.2%, the rate has been climbing consistently for over 5 years now together with falling sales. 2010 delinquency rates were still a hangover from the 2008 recession in my view, and i believe we are headed back towards even higher delinquency rates going forward.
What might be more worrying is that the 60-day delinquency rate as opposed to 90 is at new post-recession highs. Further, the average amount financed per car loans continues to rise, passing $31,500 as of the latest reading from the St. Louis Fed. All together this means that there is more demand for sub-prime ABS loans while delinquencies rise and the absolute amount of borrowing rises as well. This is reminiscent of the period of time when mortgage bond prices stayed afloat all while the subprime market was collapsing. Even if it is not an exact parallel, the auto sector does not seem like a healthy market. The chase for yield has taken the sense out of investing in securitized car loans, just as it did 13 years ago for housing.
Meanwhile, this dismal reality has been reflected in the relevant stocks for quite a while now. The leverage ratios of the largest car companies continue to deteriorate. At Ford (F), total long term debt has remained basically steady while its stock price has been nearly cut in half since June 2014. Ford’s extremely high dividend yield of 6.5% should be a sign of alarm, not opportunity. I do not see any good prospects for recovery in Ford’s stock price in 2020.
The situation at General Motors (GM) is even more alarming in terms of trend if not absolute figures, which are not as worrying as Ford's. The stock has been in a trading range since the beginning of 2011 and debt has skyrocketed from $5.3 billion after its bailout from the 2008 disaster to nearly $90 billion now in combined long-term and current debt on its balance sheet. Bulls will argue that this debt is how GM executes car financing for its customers so the leverage figure doesn’t really matter. In my opinion debt is debt, and the direction is not a good one and must end at some point.
Chinese, US, and EU Sales
The structural debt problem in the auto industry is hard enough to overcome on its own. It’s almost impossible to overcome when sales have been stagnating for years, now falling, in the most significant markets. China is particularly worrisome. Below is a graph of its car sales since 2008. Sales topped in 2017, though they did stall in 2012 as well so bulls could argue this is a blip. However, if the stagnating trend continues into 2020, then we could be looking at the beginning of a major industry-wide decline.
Sales in the European Union aren’t doing any better. Volkswagen (OTCPK:VWAGY), the largest European car-maker by market share, has seen sales decline 1.7% for the first 3 quarters of 2019. True, revenue has been up by 6.9%, but to me that shows signs of price inflation rather than real growth. According to GM’s last 10Q page 34, total car sales for the entire auto industry in Europe declined by 0.92% in 2019, which is comparatively better than the global trend with sales down 3.27% in 2019, but there are two added challenges here.
New Emissions, Fuel Regulations
New tough emissions standards out of the EU have now taken effect and they are bound to hurt profitability. Emissions standards proper have significantly tightened, and IMO 2020 is now in effect for higher fuel standards for the shipping industry, which will now be forced to compete with the auto industry for low-sulfur fuel. IMO 2020 hasn’t created an oil price spike as I thought it would, but it will still raise the cost of fuel more than otherwise. This is an economic truism. It can only be a negative for the auto industry overall.
As for the new emissions standards, by 2030, new cars in the EU will have to see emissions cut by 37.5% and new vans by 31%. That’s a herculean task and recall what happened in 2015 with Volkswagen, which installed a defeat device for emissions tests on its diesel cars and got caught in the act, following which the stock collapsed. Either European car companies will have to seriously invest in lowering emissions significantly this decade, which will crimp profits while sales are already slowing, or they can cheat like Volkswagen did (and that was before these new, even tougher regulations), eventually getting caught and seeing a collapse in their stock prices. Either way, it’s not good for investors.
Bulls would argue that the popularity of electric cars and other zero emission vehicles will help combat the trend. Maybe so, to some degree, but I don’t believe it will be fast enough to combat the interest rate pressures and general economic decline due to the credit cycle already turning and real interest rates negative still throughout the Eurozone.
The Nasdaq, S&P 500, Dow, have all continued higher, but the Dow Transports has stagnated since 2017. This stagnation has been reflected in auto industry stocks, the most significant of which have either stagnated or fallen. The structure of the auto loan market is as unstable as the loan market in housing was in 2006/07, sales are stagnant to falling, and regulations are getting tougher.
True, if electric cars really take over a collapse could possibly be averted, but this is a longshot in my opinion. Auto stocks will most likely continue to fall with sales as the 2020’s begin.
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.