Value Line is regarded as the best independent research available. More than just recommendations, Value Line provides the rationale behind its picks for greater understanding.
- Don D., California
Keeping Tabs On Inventory
Much of the retail automotive industry has been happy to see that business conditions have rebounded following a prolonged period of weak sales. Customer traffic levels have been on the rise and overall purchasing has increased. Some of the largest companies, such as Penske Automotive (PAG), Sonic Automotive (SAH) and Asbury Automotive (ABG), have boasted double-digit gains in comparable store new car sales. Still, the celebrating may be short lived, as dealerships struggle to keep up with the recent surge in business. Indeed, a cautious outlook within the industry and in much of the economy has led to a vehicle supply shortage. This, in turn, has resulted in many retail automotive corporations, as well as independent dealerships, missing out on the recent boost in customer traffic in showrooms. Making matters worse is the fact that visibility within the industry remains clouded and there are concerns about how long the uptick in selling will last. This could conclude in a nightmarish scenario, where dealerships miss out on a large chunk of business and end up stuck with a glut of inventory, as industry conditions fall back to prior levels.
The problem is multifaceted, but it starts with the auto manufacturers. After decades of overproduction, companies such as Ford (F), Chrysler and General Motors have tightened the spigot. Labor cutbacks and plant closures (not to mention bailouts and a bankruptcy) reduced the overall volume of cars and trucks produced and shipped. These conditions were adequate for retailers, as vehicle demand dried up for much of 2008 and 2009. Many dealerships were able to lower inventory from surpluses to relatively lean levels. Some companies, like Penske Automotive and Group 1 Automotive (GPI) even registered decent operating results in the process. However, over the past few quarters, the market has shifted dramatically, and the major auto producers have not changed course. In fact, companies such as GM and Ford have been fine with the status quo, and why shouldn’t they be? Ford recently generated its first 12-month profit since 2005, and GM reported its second consecutive quarterly profit in years. Industry and government officials alike have applauded the newfound discipline of the American auto sector and none of the Big Three are likely to trace the steps that led to the prior devastation of the industry.
The resulting impact, however, has forced many auto retailers to scramble to fill their lots. The irony is that dealers that were just recently stocked to the brim with excess inventory are now faced with a drought. The owners of dealerships have literally begged for more cars from companies that just years ago flooded them with unsellable vehicles. Others are dumbfounded on what to do. The uncertainty of the market has created two very different viewpoints within the sector. Some describe the current situation as healthy, while others are genuinely stressed about lost business from the shortage and the possibility of another looming downturn. Generally, it is the smaller independent dealers that have been reeling. Their weak relationships with producers have dealt them the bottom of the barrel in terms of vehicles. Meanwhile, larger retailers, such as Sonic and Group 1, are more optimistic about the current environment. The leaner inventory has reduced floor plan expenses and boosted profits. Moreover, inventory levels for them haven’t fallen enough to cause a major problem yet. Regardless of opinion, it is unlikely that the matter will be fully rectified in the near term, and most dealers, particularly small ones, will probably experience lower growth this year than previously anticipated.
There is also likely to be an impact on the consumer. A shortage of domestic new cars will probably continue to push up prices and increase the number of imported vehicles on the market. The lack of vehicles in showrooms and on the lots will also be an inconvenience for potential purchasers. Additionally, lower shipping volumes may result in higher transportation costs, which are likely to accrue to both retailers and consumers. Right now, it’s the production side of the industry that stands to win out in this economic climate. If anything, the current situation is representative of the country’s desire to see the domestic auto makers shape up, even if it is at the expense of everyone else.
At the time of this article’s writing, the author did not have positions in any of the companies mentioned.