The US Auto Industry is about to Implode – Michael Alkin

The US Auto Industry is about to Implode – Michael Alkin


[Music] so I spent 20 years in the hedge fund business looking for things at inflection points companies like or industries like uranium when they’re down in very long bear markets or companies that are trading near peaks and industries that are trading near Peaks now what I realized with Wall Street and the investment community is when things were at Peaks they look good until they’re not we move this could we get a little help here moving it forward so what we’re gonna talk about is history repeats itself but it often it doesn’t repeat but it often rhymes so what I’m talking about that is in cyclical industries when things are going well the street tends to extrapolate the current environment into the future and that what we’re seeing right now I want to talk about an industry that I think is about to implode and I want to talk about the US auto industry it’s about 5% of US workforce it represents 3 percent of GDP about 150 billion dollars a year worth of exports and about half of the companies in the Dow Jones Industrial Average rely upon it as you can see it’s had a huge move you that chart doesn’t go back to oh 9 but it bottomed out at about 9,000 units nine million units and it’s now up to 18 million units on an annualized run rate average price of vehicles have increased from third twenty eight thousand to thirty six thousand a twenty seven percent increase which has been a huge huge boost to the automakers margins the part makers margins and everyone else it’s been driven by jobs rising wages low gas low interest and in recovery of the housing market is driven to shift into the SUV vehicles so everything in the industry is soared but there’s something that’s interesting that’s developing is right now for the average incentive for vehicle is 40 300 bucks per unit now that is out of the last 18 months 17 times it’s averaged over ten percent and they’re still having a hard time moving units as the this our this year was down a couple of percent and is projected to be down next year so something’s unusual when you see the big three us makers when you have record units and you’re seeing sales down 2% 1% fiat-chrysler eight percent there’s something that’s hiding out there on the horizon if you look at the all the makers in the US you could see there’s a lot of red on that chart despite sales so what drives the US auto market it’s used cars it’s the pricing of used cars that drive it in the last recession used car prices fell off a cliff new car volumes were very low at nine million so you didn’t have a lot of trade ins into the market so you had a very limited supply and once you got that limited supply you started to see used car pricing start to surge its supply demand so when we think about buying a car leasing a car it comes down to one thing for the average person it’s all about the monthly payment so as used-car prices are increasing we have high used car values it leads some more equity in the car which leads to higher residual values the difference between the price of the car and the residual value is the gap determines your monthly payment mix in some low interest rates and you had really low monthly payments with those low monthly payments you’ve had a lot of car sales and a ton of trade ins so if you think about it am I going to buy or lease I could buy a forty five fifty thousand dollar car where I could lease it for four hundred bucks a month they becomes a no-brainer after a while so what’s happened you’ve seen a huge surge in leasing if you look from 2012 because residual values are adjusted up by the manufacturer as the values are going up in used cars you’ve seen a tremendous amount of cars being leased well that’s fine but look it’s become like crack for the car makers look at General Motors in 2009 lease penetration rates were 2% there now 27% Ford up to 23% from 5% so what’s driven that leasing low interest rates and now you have millions of cars coming off lease that are going into either the user or the wholesale market and that’s starting if you look back in the chart earlier use car pricing it is starting to roll over very hard now here’s something interesting and it kind of reminds me back to something around the global financial crisis low interest rates easy money that’s the amount of money spent on borrowing for the auto sector it’s up to 1.2 trillion dollars in debt it’s gigantic 20% of that is subprime auto 23 million consumers hold subprime auto loans mainly auto finance companies at 70 percent market share have 200 billion of that market and that’s those are credit scores under 620 between 620 and 660 it’s 435 billion about a third of the market is in subprime okay so what does that mean global financial crisis we saw subprime declines at about 10 percent in the auto market right now they’re sitting in the nine percent range so they’re climbing very closely so what’s happened the auto lenders the banks the credit unions they’re cutting back and it’s becoming much more difficult to get loans does this start to sound familiar to what we saw in the in the global housing crisis right so we have record lease explorations pressuring used-car prices residual values follow car follow the car values the affordability gap because of lower car lower used car prices is widening less cars are going to be sold subprime auto delinquencies are going to climb through the roof auto manufacturers have become increasingly and heavily dependent on leases and subprime customers and if you think about the sector’s how one if you own stocks in this area or you think about shorting stocks it’s it’s across the entire auto sector from car makers to auto finance to auto parts to auto retailers all are trading at peak margins the fundamentals are signalling that trouble is ahead and the stocks have not yet reacted as the stocks are hitting at highs another sector I think that has been a beneficiary of yield tourism I call it and easy money flowing into sectors has been the consumer staples sector and one of the things I say a lot is don’t confuse a brand you know for a stock you should own until now it’s been a huge run the last 15 years you’ve had dramatic cash flows strong earnings and investors and they pay a super-sized dividend of about two and a half percent annually compared to interest rates now and you’ve also had those yield tourists people who couldn’t afford to keep their money at zero interest in the bank they come in and buy these stocks and they say you know what I used these brands every day how bad could it be I trust them right so called safe investments you’ve seen money pouring in been a heck of a run if you own the consumer staples ETF it’s been a monster move the problem is valuations are at record highs now you never short a stock because evaluations valuation means nothing who is anyone to determine what somebody’s going to pay but when the fundamentals are starting to show a different story then that’s when it matters but the growth doesn’t support these valuations norther the fundamentals and I think you’re going to see a tsunami of earnings misses over the next 12 months and the demographics so what’s the problem the demographics these companies are getting squeezed by both sides there’s ninety some odd million Millennials and there is 70 some-odd million baby boomers at the top end you have the baby boomers everyone knows we’ve got an aging world the cohort of people turning 65 and older is rising dramatically it’s the fastest growing cohort of population but that’s just us here that’s in many countries and as we get hold older our spending habits change we spend 40 percent less from age 45 to 74 you peek at 70 thousand dollars per household and you go all the way down to 40 and you spend less on consumer stuff you spend more on insurance and healthcare and everything else for instance spending on food declines 35 percent from 80 400 to 5,500 retirees spent a lot less on soap an ordinary household sundries now you multiply those spending cuts in the u.s. by 50 million retired people that’s a 1 and a half trillion dollar cut to consumer spending and that hurts also retirees they’re more health conscious and and and they’re they’re using less of what the big guy sells right so instead of eating Oreos at night they’re rotating into fruit the big guys don’t sell fruit that’s not how these consumer staple company built their business the bigger issue for the brand marketers are the Millennials they’re a nightmare for them these are folks born 1980 to 2000 it’s the biggest in the US history there’s 93 million of them more than half of them don’t trust any of the brands that their parents bought I grew up trusting my parents brands but they don’t trust what what these kids don’t trust what we trusted their affinity for technology’s completely reshaping the way they buy they buy they have more choices and they willing to spend less everything is at the ins fingertips they could comparison shop and they experiment with new brands all the time they don’t want a story that they read it they don’t even watch TV they don’t want a commercial on TV telling them what to buy they want a local organic homegrown story and that’s what they rally around so how did the big brands respond to this they say okay well we’re gonna go buy those brands you know what they do they pay big stupid fancy multiples of earnings or cash flow and once they buy the company the Millennials rotate out into finding the next new one so these deals normally don’t work for them but what happens Wall Street does what Wall Street does they just turn a blind eye because the numbers have been okay stocks keep moving higher but look at these numbers average sales growth two and a half percent for the past three years which is half the growth rate of the SMP cash flow growth has grown just 6% much slower than the overall market now so what was the playbook how did the companies continue to grow earnings over the last several years very simple coming in at a global financial crisis they cut a tremendous amount of sgna and that helped their margins they used their very clean balance sheets to go out and take advantage of very low interest rates and add a lot of debt to their balance sheets to go and buy back stock when you reduce the share count your earnings go up so declining sales gets offset by cost cuts and a share buybacks but here’s the problem the balance sheets of many of the big guys are getting to the point where it’s hard for them to go borrow more they’ve already learned that buying what the what the Millennials want doesn’t work and they have no answer to offset the declining baby boomers and what you can see here is when you look at into the year cy1 cy+ – those are the estimates from Wall Street revenue ebody they’re starting to decline yet the stocks haven’t reacted yet and one thing I can tell you is when those numbers start to come down and they start to miss earnings you’re going to see that these stocks get sold off hard and these stocks have a lot of people in there that don’t they are just owning them because they’re tourists they’re getting the dividend yield and as soon as something happens it’s going to be Kate borrow the borin door on the downside and these stocks are sitting at nosebleed levels so there you have it the Otto cycle I think is that the margins have peaked you’ve got declining fundamentals and the same with the thing with the consumer staples [Music]


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