Financial Mail - Investors Monthly
THE CAR MARKET — HIT AND RUN?
There seems to be a glitch in the matrix — used car prices are going up. The Finance Ghost looks at how investors can take advantage of that
Usually, a car is a horrible investment. Cars lose value faster than a Springbok coach loses popularity after a bad result. New cars are the worst, though used cars are also capable of shedding 15%-20% in value every year.
Occasionally, there’s a glitch in the matrix. Used car prices are going up and a cursory search of the classifieds will confirm it. If there was a model you had your eye on a year ago, the price is now 10%-30% higher.
For an objective measure, the Manheim US used vehicle value index is being watched by investors. This measures pricing trends at wholesale auctions, so the data is much cleaner than trying to figure out what prices were achieved in private deals. The index is relevant for US inflation data and its impact on markets.
In September alone, the index increased 5.3%. It’s now 27.1% higher than it was a year ago. A used car showroom is more like a garden nursery under these conditions, with the stock climbing in value each month. That’s useful when you’re clearing old stock that you bought cheaply, but isn’t great when you need to bring new stock in.
To understand why used car prices are climbing, you first need to understand what is going on in new car production. There is a terrible backlog in global supply chains, driven primarily by the chip shortage and made worse by pressures from other commodities. There are also country-specific Covid challenges that are affecting certain manufacturers — for instance, GM is struggling with its supply chain in Malaysia.
Eye-wateringly high shipping costs are exacerbating the inflationary conditions, as ports and shipping companies struggle to clear the backlog and keep up with demand. The net result of these pressures is that deliveries of new models are delayed and prices are going through the roof.
In May, management consultancy AlixPartners forecast that the supply chain issues would cause 3.9-million units of new car production to be lost this year. In September, that forecast was increased to 7.7-million, as the full extent of
“ The automotive supply chain is like Eskom; there’s simply no margin for error and no ability to face surprises without the lights being turned off
the issue came through the system. The report estimates a $210bn hole in revenues for the industry.
The firm also points out that the issue goes beyond chips. There have been resin and steel shortages as well, along with labour challenges during Covid, which ties in with the latest commentary from the likes of GM.
The automotive supply chain is like Eskom; there’s simply no margin for error and no ability to face surprises without the lights being turned off. Audi CEO Markus Duesmann was quoted by Reuters as saying that the chip shortage is a “perfect storm”. Tesla’s Elon Musk sees the chip shortage as the major risk to Tesla’s growth, though he believes that things should be back to normal before 2023.
The key takeout is that automotive manufacturers are navigating difficult times with varying levels of success. This has a direct result on the rest of the value chain, which is so extensive that it includes platinum group metals at one end and motor dealerships at the other. Our focus is on the latter.
For consumers faced with a long waiting list and substantial price increases, the used model on the showroom floor starts to look tempting. With the advantage of deals being financed at low interest rates, buying used instead of new becomes an easier choice.
Any change in consumer preferences can cause sudden pressures in a market, as the steady-state rulebook is thrown out the window. As consumers are willing to pay higher prices for used cars because of the price increases of new cars, this causes a supply squeeze in used cars as well.
Any trader or investor will confirm that momentum is a crazy thing. We’ve seen some extraordinary price action in commodities over the past 18 months, with industry-changing peaks and troughs. Used cars aren’t so different to that, with a finite supply in the world and demand driven by low interest rates and excess liquidity in the market.
The used car dealerships market is highly fragmented in SA. Independent dealers live hand-to-mouth and need to keep buying and selling stock so they can cover overheads every month, because empty shops don’t pay the bills. This makes the squeeze worse, as most dealerships cannot afford to wait around for the price to normalise.
If you can imagine the used car market as a stock chart, we are in a situation where the chart has gone parabolic but investors are still forced into monthly investment debit orders. Even when they can see that it’s becoming a greater fool theory, they have no choice.
The bag holders are the investors who got in right at the top. Once the price plummets, they are left holding the bag. If they sell, they lock in a loss, so many choose to hold for an extended period in the hope that it all comes back. There is a risk of used car dealerships holding the bag here, especially those with lower stock turn.
As the forces of supply and demand eventually create an equilibrium, there will be a price point at which people stop buying cars. A rapidly rising oil price could get us there sooner, as demand for automotive travel drops as it simply becomes too expensive to do the mileage we’d like to do.
If a decrease in demand causes a violent reversal of the trend of increasing prices, then dealers with too much inventory will find themselves sitting with stock that they paid 20% too much for.
The margins in this game aren’t fantastic and the products are fungible (a Toyota Fortuner is the same regardless of which dealer you buy it from), so being stuck with expensive stock can be a deadly blow to a dealer.
The key measure to watch is demand, both internationally and locally. As the international market normalises, SA new car dealers will catch up on orders and waiting lists will normalise. Interest rates are also important, with any hawkish behaviour from the Reserve Bank likely to rein in consumer spending.
In the US, new car sales in September fell by about 25%
The used car dealerships market is highly fragmented in SA. Independent dealers live handto-mouth
From discussions with independent dealership owners and based on these numbers, the industry is consolidating and leading players are winning share
year on year. Cox Automotive estimates used vehicle sales for the month were down 13% year on year. Though there is clearly a rotation from new to used cars, there’s also a rotation into not buying a car at all. These are durable goods and people can keep their existing cars when prices are silly.
In SA, new car sales are well up on last year but below 2019 levels. When considering listed companies like Combined Motor Holdings (CMH), the important number to isolate in Naamsa data is local passenger vehicle sales, as export and heavy vehicle stats can significantly skew the data.
By September year to date, passenger vehicle sales were 31% higher than in 2020 but nearly 14% down on 2019 numbers. Naamsa tracks new car sales, so this only tells part of the story. To get the bigger picture, Stats SA releases a motor trade sales report. Unfortunately, the data isn’t nearly as fresh as Naamsa’s monthly flash sales. The latest available Stats SA report covers the period to July 2021.
Interestingly, the Stats SA report looks at the rand value rather than the number of units. It doesn’t differentiate between passenger and other sales, but it does show that on a rolling three-month basis (May to July 2021 vs the comparable period last year), the value of new vehicle sales grew 35.4% while the value of used vehicle sales grew 24%. Workshop income (which contributes about 7% of total motor industry sales) increased 29.5% over the same period.
For those three sources of income combined, the 2021 absolute number is almost identical to 2019. With two years’ worth of inflationary growth in expenses, we must assume that the industry is running at lower levels of profitability than before Covid.
You wouldn’t say so by looking at CMH, the best pureplay example on the market of an SA-focused car dealerships group.
A recent trading statement, for the six months to August 2021, gives interim headline earnings per share guidance of 190c-210c vs 120.9c for the same period in 2019.
WeBuyCars is also flying, with Transaction Capital now the owner of a 74.9% stake in the business. Within 18 months, the group expects to reach 10,000 unit sales per month. More than 8,000 units were sold in March 2021 and there is significant investment under way in new capacity, including the transformation of the Ticketpro Dome into a WeBuyCars “supermarket” — I wouldn’t bet against that management team.
Motus is an international business and has a more diversified model than CMH or WeBuyCars. For the year to June 2021, a period that includes lockdown-disrupted sales particularly in the first few months, revenue grew 9% vs the 2019 period and profit before tax grew 10%.
There’s noise in all these numbers. Comparing profitability to industry growth is dangerous, unless the difference is so big that we can safely infer a trend. From discussions with independent dealership owners and based on these numbers, the industry is consolidating and leading players are winning share.
Betting on CMH is a bet on the old-school dealership model, which made a lot of money through cheeky trade-in offers related to sales of new cars. WeBuyCars is the high-volume disruptor of that model. Motus is the most diversified player.
Think carefully about which one you put in your garage, especially when the music stops on price hikes.