The Troubling Signs for GM, Chrysler, Ford, and the Auto Industry (w/ Daniel Ruiz)

The Troubling Signs for GM, Chrysler, Ford, and the Auto Industry (w/ Daniel Ruiz)


DANIEL RUIZ: My name is Daniel Ruiz.
I’m the founder of Blinders Off Research.
I focus on consulting and research products
for the automotive sector.
DANIEL RUIZ: So I think it’s important to
start with a quick recap of what’s happened.
My original interview in with Real Vision
was in 2017.
It was at a time when auto sales were slowing
down significantly.
GM had a very high day supply of vehicles
that they were trying to work through.
And things, from a good short opportunity
perspective, looked very, very good.
We had a bit of a surprise in August with
hurricanes that both reduced the size of inventory
of new vehicles but also spurred replacement
demand and kind of jumpstarted the auto sector
a bit for a couple of months.
Shortly thereafter, I actually reached out
to Real Vision again.
And I said this is a really, really good opportunity
to re-engage a short position in several different
names.
And the reason why was, primarily, because
of what was happening with the used car markets.
Dealers anticipated demand would increase
substantially from folks looking to replace
vehicles that were destroyed in the floods.
So what they did is they speculated.
And they went to the wholesale auctions, and
used vehicle prices increased substantially
because of that.
I saw a big problem with this because I didn’t
view it as healthy demand.
Healthy demand is, when you sell a vehicle,
you go to the wholesale auction and you replace
it to maintain proper inventory levels.
This was speculation.
And what it led to was a very, very large
spike in used vehicle values in September.
I should state that I look at used vehicle
values as consumer purchasing power because
so many of the new vehicle transactions involve
a used car trade.
So this was all very healthy for the auto
industry in the short term.
But it wasn’t something that was going to
last.
And sure enough, a couple of months after
stating these concerns with Real Vision, again,
in terms of an article that was written, used
car values declined substantially.
We did finish 2017 with lower sales than we
did the prior year, which was an all time
high.
And again, the short thesis was looking very
strong through the first two months of 2018.
I have long term indicators that help investors
gauge the climate, the demand picture, going
forward for a long period of time.
But I also have shorter term indicators that
act as an early warning system if something
is going wrong or as an indicator that things
are progressing the way that your short thesis
envisioned.
DANIEL RUIZ: So I’m going to discuss a few
indicators that are very highly regarded in
the auto industry but also a few economic
indicators that are heavily relied on in the
industry when it comes to forecasting vehicle
sales volume and also are important to margin
as well.
And by that, I mean how it specifically relates
to publicly traded auto companies.
In order for a company, as a general rule,
to have their stock price increase, they need
to increase revenue and earnings over time.
And the way that you increase revenue and
earnings is by increasing the volume of production
when we’re talking about companies like Ford,
GM, Fiat Chrysler.
There are several indicators that both these
companies and other folks that cover these
auto stocks use to gauge future performance
of production volume and also how margins
might be impacted.
So I’m going to start with industry specific
indicators that that are often communicated
to investors, to analysts by manufacturers,
publicly traded dealers, that help give some
sort of future guidance into demand.
And one that’s heavily relied on, one that
was actually used very recently by GM at investor
meeting, was the average age of vehicles that
are registered.
So the thought pattern here is, as the vehicle
age increases, you can assume that there will
be extra demand because the vehicles will
need to be replaced at some point.
The challenge with this that I know personally
from boots on the ground experience is that
folks that own very old vehicles– I believe
the average age right now is around 11 years–
they don’t tend to trade those vehicles on
brand new vehicles.
They trade those vehicles on pre-owned cars,
on certified preowned cars, on seven or eight-year-old
vehicles.
They don’t upgrade in steps that large.
So if you look at the chart, you can see that,
starting from 1976 to current time, the average
age of vehicles has just gradually increased.
And that’s because the vehicles are better
built now than they were before.
So they last longer.
But the vehicle has multiple owners through
its lifecycle.
So the vehicle can be re-marketed several
times throughout its lifecycle before it’s,
ultimately, scrapped.
It is not in any way, shape, or form a good
indicator of demand for new vehicles sales
for the reasons that I just stated.
So the thing that I would caution investors
on or analysts when looking at that data,
that indicator itself, vehicle age, should
not be used in my opinion because, again,
folks that own older vehicles are more prone
to buy used vehicles than they are new vehicles.
The volatility that you see in new vehicle
sales, there’s no leading volatility in vehicle
age that would make you assume that, like
for example, if the vehicle age all of a sudden
dropped dramatically, future demand for new
vehicle sales would fall.
So we can’t make that assumption based on
that data, and we shouldn’t.
DANIEL RUIZ: Another industry indicator that’s
heavily relied on is the amount of vehicles
that are scrapped?
The reason why investors and analysts look
at this indicator is because the assumption
is the more vehicles that are scrapped, the
more vehicles will need to be replaced.
But again, going back to what we discussed,
the vehicles that are being scrapped are older
vehicles.
And the folks that are scrapping those vehicles,
of course, they’re going to replace them with
another.
But it’s not necessarily going to be a new
vehicle.
They’re buying pre-owned cars, certified pre-owned
5, 6, 7-year-old cars.
So again, it’s not a good indicator for Ford
demand of new vehicles or vehicle production.
As you can clearly see in the chart, there’s
very few instances of direct correlation between
new vehicle sales and the amount of vehicles
that are being scrapped.
DANIEL RUIZ: So I’m going to move on to heavily
relied on economic indicators.
This is important because, in almost every
communication from analysts, from manufacturers,
you’ll see something about the employment
rate and how important that is to future demand.
The challenge is that, when we look at a chart
of the unemployment rate and previous auto
cycles, in almost every circumstance the auto
cycle has peaked ahead of unemployment rising.
It’s a lagging indicator.
And there are things that are more crucial
to new vehicle sales volume than just employment.
It’s obvious that you need a job in order
to purchase a vehicle.
It’s obvious that you need income.
But there are other things that slow down
the velocity of new vehicle sales, which we’re
going to discuss in a moment.
The other economic indicator that’s very heavily
relied on, specifically, not so much to volume
but margin.
Something that’s looked at for forecasting
pricing power is income.
As you can see in the chart that I’ve provided,
the average household income has always peaked
after auto cycles as well, which, again, leads
you to the conclusion that it’s important.
But it hasn’t been a leading indicator in
previous auto cycles.
So we shouldn’t rely on it.
Unemployment and income matter a great deal
when you’re in the middle of a down cycle
because you can use it to gauge how severe
that down cycle is going to be.
But it’s not a good predictor of in an auto
cycle.
DANIEL RUIZ: So now going to move onto what
actually works.
And I should preface this by saying that what
led to these indicators that I’m going to
share with you right now was really frustration
as an analyst myself and as a consultant myself
because I couldn’t find any correlation or
a strong enough correlation to utilize any
of the indicators I just mentioned in a way
that would help investors and in a way that
would help forecast future volume and margin.
I started thinking back to my 15 years in
the automotive industry and what I experienced
with consumers.
And the obvious nonstarters, as I mentioned
before, are if you’re not employed, you’re
not going to get an auto loan.
If your income isn’t sufficient, you’re not
going to get the auto loan.
If your credit is bad enough, you’re not going
to get an auto loan.
And that’s more specific to new vehicle sales
because you can always find a home for somebody
with bad credit as it relates to a vehicle
if it’s old enough and inexpensive enough
to offset the higher interest rates.
But it’s very difficult on a new car sale.
The biggest challenge that I always ran into
was trade-ins and the level of equity that
the consumer had in their vehicle.
That was one of the strongest objections that
I continuously encountered in the auto industry.
So it led me to start digging into, is there
any correlation historically to equity and
consumer behavior?
I should also state that this is extremely
important because 87% of new vehicle sales
in the US are financed.
On average, those vehicles that are purchased
new that have debt attached to them are traded
within three years.
So we know, based on the average loan term,
the majority of folks that are coming back
to trade their vehicles have an outstanding
balance on their loans.
And the relation to it with the used car value,
their specific vehicle, and the principal
balance that’s owed on that car is what often
determines whether they’re going to purchase
a new vehicle or not.
What I’ve noticed is, throughout those transactions,
if there was equity in the trade, the likelihood
that a consumer would move forward with a
new purchase was very high.
If there was negative equity on the trade,
what most often happened is they would purchase
a car but just not right then and there.
They would delay that new vehicle purchase
simply because they were reluctant to raise
their previous monthly payment.
So what I wound up doing is I created my own
indicator through my research.
And this is the one that I find has the strongest
correlation to new vehicle cycle highs and
lows.
I call it time to equity.
And that, in essence, what I’m trying to do
is I’m trying to gauge the health of a three-year-old
loan that was originally a new vehicle purchase.
I do so by taking the average transaction
price, the incentive data for that particular
year, the average loan for that year, and
the average interest rate.
I then amortize that loan, and three years
forward, I take the value of a three-yearold
car.
And through a proprietary formula that I developed,
I can identify the month in which that consumer
or that group of consumers would reach the
break even point on their loan.
So at the point where the used car value outweighed
the principal balance owed.
I then charted that data, starting in the
early 2000s to current day.
And I found that my suspicions were correct
as far as consumer behavior and equity go.
The faster consumer reaches the break even
point, the faster they’re going to purchase
a new vehicle, which increases new vehicle
sales velocity.
The longer it takes them to reach equity,
the longer it’s going to take for them to
purchase a new vehicle, which decreases new
vehicle sales velocity.
And you can see in the chart that I provided
that time to equity peaked in 2008.
And that was at 36 months, I believe.
And the new vehicle sales bottomed in 2009.
Folks don’t stop buying cars.
They just delay it until it’s a better proposition.
And I should state that there were other things
that made the last down cycle in autos as
severe as it was.
But the time to equity indicators is, I think,
one of the best indicators moving forward
to gauge consumer demand.
And the reason why is because it’s telling
us how long it’s taking them to get to equity
on their loans.
And the surprise in 2018 was used car values
increased dramatically, which offset the longer
loans and higher interest rates.
So 2018 would be folks that purchased in 2015.
Used car values increased so much that it
actually offset the longer loan terms that
they took and the higher interest rates that
they paid during that time period.
Interestingly enough, when I take the abnormal
used car appreciation that we had in 2018
and I plug it into the grouping for 2019,
as it relates to time to equity, you can see
that time to equity spikes up to 33 months.
And that’s just solely from the extended loan
length that buyers took from 2015 to 2016
and the increase in interest rates.
The important takeaway from that is I don’t
expect used vehicle values to remain as elevated
as they did in 2018.
That’s something that was extremely rare.
Every one residual point drop will increase
time to equity by one month.
So if we have a fall of residuals by as little
as 3%, which is really not a lot, we’re going
to be right back to the 2008 high in terms
of time to equity, which is going to put serious
pressure on new vehicle sales.
The other reason why used car values are so
important is because they determine where
captive banks are going to set residuals.
As you can see in the chart that I provided,
if used car values fall, residuals are going
to fall, which, in turn, increases monthly
payments and will have a negative impact on
new vehicle sales.
There’s a very, very tight correlation between
lease originations and new vehicle sales.
Autos Looking forward into where we are right
now, just ahead of Q4 earnings, I provided
three charts that are wholesale estimates.
This is a product that I offer to kind of
give investors a early warning on what their
expectations are, whether they’re long or
short.
So they can plug the information into their
financial models in a way that that’s more
accurate than just using a SAAR number.
DANIEL RUIZ: And as you can see, for Ford,
the wholesales are just slightly under last
year.
But importantly, I’ve broken up the car truck
and SUV mix.
And the mix is much better.
So we can assume that volume is going to be
the same in the US.
But the mix of trucks and SUVs are much higher.
So that’s going to equate to higher margins
when they report.
And Ford is actually a company that I think
is a good opportunity at this point to accumulate
shares in.
I don’t think that the down cycle is over.
I think that we’re just getting started.
But it’s a company that’s heavily discounted.
It’s a company that, over the years, has done
the right things, in my opinion, in terms
of lowering contracted residuals, managing
inventory.
They have a new truck that’s coming out, which
should be a very, very big positive for volume
and margin because it’s not replacing a vehicle,
which is important.
It’s not a net difference to the bottom line.
It’s going to be a straight add in terms of
the new Ranger.
I like what they’re doing with autonomous
technology.
They’re focusing on commercial use rather
than personal use, which, I think, will have
a much higher adoption rate.
DANIEL RUIZ: Although we’re going into Q4
with GM being somewhat flat in volume and,
I would assume, a little bit better mix as
well because they just recently put out their
new Silverado, going forward, I think GM and
Fiat are both good short positions.
And this is a big contrarian because most
investors, especially value investors, look
at those stocks, and they see the low PEs.
They see the margins.
They see that that new vehicle sales haven’t
dropped off as much as some folks anticipated.
And so they think they’re good purchases.
But I disagree.
Again, time to equity tells me that volume
is going to drop off.
Inventories will likely increase, which puts
pressure on margin when manufacturers have
to increase incentives to sell the new vehicles.
And I think that both revenue and earnings
are going to be pressured going forward for
both GM and Fiat.
FCA is probably the toughest one to call.
And it’s the one that I think investors are
most in danger of if they’re on the long side.
And the reason why is because, again, from
a value investor standpoint, their balance
sheet looks terrific.
Their sales were up 8.5% this year.
But something that’s important to note here
is that, again, going forward I think that
sales volumes are going to be pressured for
the reasons I mentioned but, also, the thing
that they did, which was very dangerous and
kind of surprising, is they actually overproduced
significantly.
And in October, they had 100 days supply of
new vehicles.
It’s dropped down to 89 days in December.
But that has a lot to do with seasonality.
I say that because they factored day supply
when it comes to just the prior month sales.
So to give you a quick example of what I mean
by that is, if they had the same amount of
inventory in January and their sales increased
by 10%, they’re going to have 115 day supply
vehicles.
And day supply should be looked at by investors
as margin of safety when it comes to production.
And again, that’s where the earnings for these
companies come from.
It comes from increasing production and increasing
margins.
So the production at FCA, in my opinion, is
in danger going into 2019.
I think they’re going to have a very, very
difficult time exceeding comps, both volume
and mix.
Mix is still very much an argument for the
bulls.
But I’d like to point to a chart that I’ve
provided, which shows that mix was skewed
to a dramatic point in 2018 where, at the
highest point, I believe, in August we reached
a light truck market share of 71% to 29% cars.
So expecting a higher mix of vehicles going
into 2019 to offset any volume declines, I
don’t think, is a good strategy from an investing
standpoint.
DANIEL RUIZ: The other one that I think is
a good short opportunity is Hertz.
And I say that because, again, in 2018, we
had abnormal used car appreciation.
And in Q2 and Q3, the earnings were very encouraging
after Hertz’ performance in the prior year,
year and a half.
But investors need to know that that, from
a business standpoint, as used car values
rise, their depreciation expense falls.
Hertz is a company that is in a very, very
difficult position from a revenue per unit
standpoint, in my opinion, because of competition.
You have Lyft and Uber that are servicing
the consumer on a short term basis.
On a longer term basis, you have competition,
such as Turo, which is gaining share in the
industry, and then also Maven from GM.
And then on an even longer term than that,
something that’s starting to gain traction
are used car subscription services.
So you’re dealing with a company that has
tremendous downward pressure on revenue from
competition and increasing expense in terms
of depreciation.
And I think they’re going to have a very,
very tough go going into the future.
And I think it’s a good long term short.
On the long side, again, I mentioned Ford.
I think that that Ford is a good company,
something that could be bought now.
Accumulate shares.
Take advantage of the high yields and the
valuation because they will exit this down
cycle in autos ahead of the others, in my
opinion.
But another interesting one too is Carvana.
DANIEL RUIZ: Carvana is an online only retailer.
And investors look at that company, and they
say, OK, they’re not profitable right now.
So you question the stock price, the valuation.
But we really need to look at it from a growth
standpoint.
Carvana has a significant advantage over its
competitors in terms of scaling.
To give you a quick example, a traditional
dealer will– the average cost of a new dealership,
including inventory, is about $11 million.
For Carvana, to enter a market, the average
cost is $500,000.
So from a scaling perspective, they have a
significant cost advantage over their competitors.
And truly, I just think that’s one of the
trends that should really, really be followed
in this industry, ahead of autonomous driving,
even ahead of electrification, because I think
that there’s further technology advances that
need to happen in that area in order to have
electric cars scale.
Online is something that the consumer is ready
for.
It’s something that they’ve been that they’ve
been conditioned for by companies like Amazon.
They’re used to buying items without having
to feel them and touch them.
Used car prices have– the trend is going
to one price.
So there’s less friction in that respect from
clients.
And Carvana it takes care of the fear of purchasing
a bad car away by offering a seven day return
policy.
DANIEL RUIZ: So to finish, the main reason
why I wanted to do this today was because
I want investors to focus on the true drivers
of the auto industry and not to be given a
false assurance by indicators, again, that
have very little correlation to new vehicle
sales, whether they be economic or industry
specific.
There are things that drive the auto industry
from the ground up one transaction at a time
that really matter.
And those are the things that we need to be
focused on.
And when it comes to those things, there is
serious deterioration happening, a lot of
which was masked by used car performance in
2018 that, I personally think, wouldn’t be
prudent for somebody that’s analyzing the
auto sector to plug that into a financial
model or any model that forecast future sales
shouldn’t have used car appreciation built
into it.
I think that used car values are going to
decline.
2019 is the peak in lease maturities.
I think we’re running into issues with new
vehicle pricing, which is evident in loan
terms that are increasing and very, very aggressive.
If new car pricing unwinds, that’s going to
pressure used car values.
If used car values are pressured, return rates
are going to increase, which means that there’s
going to be increased supply at wholesale
auctions, which is going to pressure used
vehicle values.
And as used vehicle values fall, time to equity
increases, and residual values fall.
I don’t think we’re in an environment of growth.
I think we’re in an environment where we’re
going to decline in the fundamental factors
that, I believe, are extremely important,
the ones that fuel growth, the ones that fuel
margin.
And I just I want to make investors aware
of the situation that we’re currently in.

28 Replies to “The Troubling Signs for GM, Chrysler, Ford, and the Auto Industry (w/ Daniel Ruiz)”

  1. Get Real Vision Premium for only $1 for 3 Months here: https://rvtv.io/YTDollarPin
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  2. A powerful interview would be Harry Markopolos, Marc Cohodes and Carson Block together. They can't make head way because of the corrupt government.

  3. Here we go again. Sooner or later, the executives form GM, Chrysler, are gong to take a Chartered flight on shareholders money and fly to Washington and ask for a larger bailout than 2008.

  4. Too expensive, poorly made, can't fix them yourself, high property taxes, expensive maintenance – what could be wrong with that?

  5. OVER 7 MILLION AMERICANS are more than 3 MONTHS BEHIND on their auto payments.

    I've seen more BOOTS on cars in the past 4 years than I saw in the previous 30 years.

    Student Loans, home price inflation and auto loans are going to turn America into a debtor prison.
    NUFF SAID.

  6. What I don't hear is the national demographics. The babyboomers are not buying cars like they used to because they are retiring and not driving much. The millenials are not buying new cars like the babyboomers due to bad credit due to studen loan debt. Gen Xers, even though they are in their peak spending years, they are too small a generation to support the market profitability. Car prices will drop soon.

  7. Everything about the economy can be summed up in one question. "Is the average person willing and able to borrow money?"

  8. How does Uber, Lyft, Turo, CarGo , electric scooters 🛴, and increase of city center populations have on new car 🚗 demand? I would never buy a new car to drive Uber because of depreciation costs with each mile. Younger people couldn’t care less about cars and don’t want the hassle of ownership. We are 3-5 years before Tesla robo taxis will be cheaper than car ownership. At $3 per trip, why would you want to buy a brand new car?$?$?$? The US government is one Democratic president away from banning internal combustion engines and force everyone to buy electric cars and solar panels!$!$!$.

  9. "33% of people who traded in cars to buy new ones in the first nine months of 2019 had negative equity, compared with 28% five years ago and 19% a decade ago." – Wall Street Journal Nov 2019

  10. Love your daily stream. Really want to say thanks for that, i strongly believe December will be very epic in crypto history ,especially for bitcoin , F.O.M.O (Fear of missing Out) will trigger the bull run, hopefully we will have a new set ATH(all time highs) above $20k in 2020, what a time to be alive and selling 1btc for over 20k usd. so everybody should buy more and join the train before its goes to the Moon as Predicted. I will also advice you multiply the little you have instead of HODL with Douglas’s strategy, After getting in touch with Douglas Murray, an expert in cryptography, who showed me how to use his program to make transactions and got 12btc in 2 months of operations with him trading with 3.2btc , if you are looking for a way to increase your  portfolio or investment, Contact him via WhatsApp: +1(832)413-2374 or mail [email protected]*

  11. I'm sick of looking at these dork mobiles on the highway. They have no style and they all look the same. If someone gave me a brand new one I would not drive it! I would sell it and go buy a nice antique car with style. The 60's and 70's style auto are vastly more artistic and cool looking then anything you see on the road today! Except Mustangs.

  12. I sold my last car 5 years before moving to a city where I don’t need one. Love not having that burden anymore, don’t really care if I ever own one again. The odd occasion when I need to rent a car I do start to miss it a bit, but given what a money pit they are I quickly snap out of it.

  13. What is this?

    Most of this guys charts and graphs have no constant pattern in the X and Y axis. He compares a graph from 2002 to 2018 to a graph from 205 to 2018.

    This is high level statistical manipulation. Do not give someone like this a platform.

  14. "If you don't have a job, or have bad credit, or low income, you're not going to get an auto loan."
    Umm, is this guy serious? The industry has built this fake recovery purely by selling cars to these type of people. My own brother in law sells Chryslers, says he can literally get anyone a new car loan. Income verification? Bah! Credit check? Only to determine how high a rate they charge you, not to decide whether you get the car that's for sure.

  15. This is what happens when a government legislates an industry into making products no one wants anymore. The added costs combined with the crappier product causes people to not buy.
    Add to that the debt nation, it’s no wonder the vehicle market is crashing world wide, let alone in the US.

  16. I hope they all fail. I am sick of these garbage quality vehicles, sick of con artist dealerships, sick of vandal-thief mechanics, sick of planned obsolescence, sick of the governments socialistic control of the industry, sick of the push for autopilot.

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