U.S. July Auto Demand: SAAR and Incentives Up, Production Down

Consumer Discretionary / Industrials

Henry Kwon

Thematic (Sector/Industry)

Italy Automobiles / Thematic (Sector/Industry)

<p>U.S. SAAR came in at 16.5M Units for 1H17 average of 17.1M units, from FY16 light vehicle demand of 17.5M units.  D3 discussions of June sales pointed to pullback in fleet volumes which contributed to SAAR weakness but pointed to stable YTD retail sales volume with continued positive mix shift towards large light trucks leading to improving average transaction price.  Positive market sentiment on auto stocks following June figures release most likely looks to peaking volumes against the backdrop of improving transaction price at the retail level.  On full year expectations, I am now looking at light vehicle demand to be weaker than I previously assumed (<strong>17.2M now vs. 17.4M previously</strong>)in <a href="https://www.smartkarma.com/insights/some-quick-thoughts-on-ytd-u-s-auto-demand-with-fy17-implications" target="_blank" data-smartkarma-citation="insights:10842">Some Quick Thoughts on YTD U.S. Auto Demand with FY17 Implications</a> based on observations of 4 macro factors I first pointed to back in May.</p><div class="content-highlight"><h2><strong>Tailwinds</strong></h2><ul><li><strong>Stable retail volume:</strong>  Thus far in 1H17 OEMs have presented that SAAR weakness has been the main culprit behind YoY decline in SAAR, and that retail mix should improve in 2H17.  Seasonally speaking this is pretty straight forward, with YTD macro factors not suggesting a fall-off in retail demand, especially with elevated incentive levels.  However, I believe that at this point both OEMs and financial markets assume that US SAAR has peaked following an exceptionally strong recovery following the GFC, so that headwind should already be priced in.</li><li><strong>Positive mix shift</strong>: This potentially favors OEMs with the largest light truck exposures which basically points to D3.  OEMs with mainly car segment exposure are least favored, as seen by the stock market reaction to Hyundai Motor and Kia Motors following the U.S. June figure releases.</li></ul><h2><strong>Headwinds</strong></h2><ul><li><strong>Increasing off-lease vehicles with potential for pricing power erosion at the retail level</strong>: Ford observed in its monthly sales call that the company expects impact to come mostly at the daily rental fleet segment rather than at the retail sales level.  As OEMs negotiate fleet volumes for 2018, an increasingly cautious stance by rental companies can lead to continued SAAR weakness into 2018.</li><li><strong>Incentives as a percentage of Average Transaction Price(ATP) has in fact been slowly creeping up since 2012.  </strong>The pace at which this occurs should be closely monitored by investors.</li><li><strong>Rising inventory</strong>: <a href="https://www.smartkarma.com/profiles/988" target="_blank" data-smartkarma-citation="accounts:988">Noriaki Hirakata, CFA</a> addressed this issue in his comments on June U.S. SAAR in <a href="https://www.smartkarma.com/insights/june-us-automotive-sales-mid-16-million-saar-pushed-inventory-days-up-again" target="_blank" data-smartkarma-citation="insights:11871">June US Automotive Sales: Mid 16 Million SAAR Pushed Inventory Days up Again</a>, this seems to be a factor that seems not to be taken in by the sellside community in company sales calls.  </li></ul><h2>Conclusions</h2><p>While positive mix shift leading to expanding ATP provides a compelling argument on the positive side, caution lies on the pace at which incentives rise to potentially erase the gains.  Tightening credit conditions could also contribute to further pressure on retail volumes going into 2H17.  YTD trackings of real wage growth, prime lending rate, housing price and unemployment rates continue to support my thesis that US light vehicle demand has peaked and that 2017 full year demand is likely to be weaker than I originally thought.  I am lowering my expectations for full year US SAAR to 17.2M units from 17.4M units based on sensitivity analysis of the 4 macro factors.</p></div>

U.S. SAAR came in at 16.5M Units for 1H17 average of 17.1M units, from FY16 light vehicle demand of 17.5M units.  D3 discussions of June sales pointed to pullback in fleet volumes which contributed to SAAR weakness but pointed to stable YTD retail sales volume with continued positive mix shift towards large light trucks leading to improving average transaction price.  Positive market sentiment on auto stocks following June figures release most likely looks to peaking volumes against the backdrop of improving transaction price at the retail level.  On full year expectations, I am now looking at light vehicle demand to be weaker than I previously assumed (17.2M now vs. 17.4M previously)in Some Quick Thoughts on YTD U.S. Auto Demand with FY17 Implications based on observations of 4 macro factors I first pointed to back in May.TailwindsStable retail volume:  Thus far in 1H17 OEMs have presented that SAAR weakness has been the main culprit behind YoY decline in SAAR, and that retail mix should improve in 2H17.  Seasonally speaking this is pretty straight forward, with YTD macro factors not suggesting a fall-off in retail demand, especially with elevated incentive levels.  However, I believe that at this point both OEMs and financial markets assume that US SAAR has peaked following an exceptionally strong recovery following the GFC, so that headwind should already be priced in.Positive mix shift: This potentially favors OEMs with the largest light truck exposures which basically points to D3.  OEMs with mainly car segment exposure are least favored, as seen by the stock market reaction to Hyundai Motor and Kia Motors following the U.S. June figure releases.HeadwindsIncreasing off-lease vehicles with potential for pricing power erosion at the retail level: Ford observed in its monthly sales call that the company expects impact to come mostly at the daily rental fleet segment rather than at the retail sales level.  As OEMs negotiate fleet volumes for 2018, an increasingly cautious stance by rental companies can lead to continued SAAR weakness into 2018.Incentives as a percentage of Average Transaction Price(ATP) has in fact been slowly creeping up since 2012.  The pace at which this occurs should be closely monitored by investors.Rising inventory: Noriaki Hirakata, CFA addressed this issue in his comments on June U.S. SAAR in June US Automotive Sales: Mid 16 Million SAAR Pushed Inventory Days up Again, this seems to be a factor that seems not to be taken in by the sellside community in company sales calls.  ConclusionsWhile positive mix shift leading to expanding ATP provides a compelling argument on the positive side, caution lies on the pace at which incentives rise to potentially erase the gains.  Tightening credit conditions could also contribute to further pressure on retail volumes going into 2H17.  YTD trackings of real wage growth, prime lending rate, housing price and unemployment rates continue to support my thesis that US light vehicle demand has peaked and that 2017 full year demand is likely to be weaker than I originally thought.  I am lowering my expectations for full year US SAAR to 17.2M units from 17.4M units based on sensitivity analysis of the 4 macro factors.

June U.S. Auto Demand Below 17M Units SAAR: Revising Down 2017 Expectations