By: Jeff Pollock
March 2, 2017
Almost a year ago (April 7 to be exact), we wrote a blog arguing that the driving forces behind North American auto sales demand were discounts and incentives. One year later, not much has changed. In fact, the problem has grown worse.
As it turns out, the lack of demand is fuelling the need for discounts and incentives to continue further.
Last month, an annualized 17.5 million cars were sold, roughly unchanged relative to January’s figure but representing a 1.1% decline from one year earlier. Consequently, discounts and incentives have now replaced the $30 per hour labour costs as the industry’s biggest headache.
Today, the average incentive represents 10.5% of the automobile’s sticker price (which works out to $3,830, up almost 20% from a year earlier), marking the eighth consecutive month that the figure has stood above 10.0%. Furthermore, about 10% of new car loans in January were interest-free, up from an already elevated 8% one year earlier.
Since our April 7 blog, the stock price performance of auto companies has been mixed. Ford Motors’ share price is down 1.2%, while GM’s is up 25.9%.
Despite its share price gain, however, GM’s sales are expected to decline 0.6% this year while earnings per share will drop by 1.1%. Meanwhile, Ford Motors’ sales will grow a mere 0.7% in 2017 and earnings per share are expected to fall 7.4%. Since GM’s Initial Public Offering in 2010 at $33.00 per share, the stock price has generated an unimpressive 2.2% compounded return per annum. Today it trades at $37.76.
Beyond North America, both Ford and GM have benefitted in recent years from their exposure to China. Many investors that own these stocks cite their Asian exposure as a core component to their investment thesis. However, both companies are likely to see only about 1.9% sales growth in Greater China this year. Not only is the market maturing but its tax incentive is phasing out. A consumption tax on vehicles with engines below 1.6L rose from 5.0% to 7.5% in January, and will increase further to 10.0% in 2018. This is likely to cause weakness in the region.
Security selection is not just about buying the stocks that will go up, but also avoiding those that will go down. At Vestcap, before adding a new security to client portfolios, we conduct a thorough examination of the company’s Financial Statements as well as the stock’s valuation. An ideal investment is found when a cheap and inexpensive stock is backed by a great company. Given the auto industry’s weak underlying industry dynamics, our view hasn’t changed from a year ago and we lack any exposure to the sector today. Instead, we’ve deployed capital into companies that have a more favourable outlook and accompany cheap valuations.
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