Friday, August 24, 2012

Weak Auto Sales, What Next for the Car Retailers?

CarMax (NYSE: KMX) gave results recently and disappointed the market with its numbers and outlook. However, perhaps the most surprising thing was that the market was surprised! Industry data has suggested that vehicle sales were a bit weaker in May and other economic data has indicated some softness with the consumer. It is hard to conclude that this is the start of the reversal of a strong trend in car sales but with the non-farm payroll numbers being weak in recent months, it is understandable that investors should be taking a cautious view.


Industry Car Data

As mentioned earlier, industry data for vehicle sales was a bit weaker in May. This can be shown in data from the National Automobile Dealers Association (NADA) and specifically the Seasonally Adjusted Annual Rate (SAAR) of vehicle sales.

SAAR (m)OctoberNovemberDecemberJanuaryFebruaryMarchAprilMay
Vehicle sales13.213.513.514.515.114.314.413.8
Note the downturn in May following some strong numbers in the previous six months.
In truth, car dealers have little visibility of future sales and their prospects are subject to the drift of macro-economic trends.  CarMax is the largest used car dealer in the US. Store traffic numbers were down, which suggests that customers are still very price conscious in an ongoing weak environment. Competition is strong from the likes of AutoNation (NYSE: AN), but I doubt the weakness at CarMax is anything other than an industry wide issue.

However, what is more concerning from the economic perspective is the relative weakness in new car sales. This has been a key part of the bullish case on the US economy this year and any sustained weakness will lead to downgrades to GDP growth expectations. CarMax reported a 5.7% gain in used car sales but a 10.4% decline in new car sales. Equally worrying was the 2.1% decline in wholesale vehicle sales.

Moreover, since CarMax is overwhelmingly a used car sales dealer, its results cannot be explained away in terms of weakness with specific models. For example, other dealers like Penske Automotive Group (NYSE: PAG) or Group 1 Automotive (NYSE: GPI) are more focused on specific car models and their sales results can vary depending on model release dates and popularity.

If there is a specific aspect to CarMax’s results it lies in the availability and pricing of used car models. Analysts grilled the management over this issue and specifically whether it was demand or supply that was the issue behind the weak performance in the quarter. The answer was that it was a bit of both.


Used Car Prices Rising

CarMax’s core sales are traditionally 1-3 year old cars and prices have been rising as fewer vehicles are available in the market. Unfortunately, the economy is such that consumers are now price resistant across the board. This could squeeze CarMax in future as it will need to purchase inventory for the new store openings whilst consumers are resisting price rises. Now does not appear to be the best time to be opening new stores.

Against this trend is the fact that third party lenders appear more willing to extend credit to CarMax's customers. Indeed, credit companies appear to be loosening in their lending standards and whilst employment gains have been weaker than most would hope for, they have still been positive. In other words, the conditions are ripe for an increase in demand, but the high price of supply may take some time before it overcomes purchasers' resistance.


So What Next For CarMax?

From a investment perspective it is always tempting to look at a negative quarter and try and write it off as a blip in an otherwise strong trend. However, in this case I think the confluence of forces that are merging toward CarMax's bottom line are suggesting a bit of caution here. Indeed, management was quite specific on the underlying issues.
"I think some consumers look at pricing and just decide to not get out there and buy right now. And I think until we see some movement in the supply and the SAAR gets back up to historical levels, then we're probably going to be looking at this for a little while."
Given that the SAAR was weaker in May and other economic indicators have been weak of late, there is sufficient cause for a bit of caution here or at least until confirmation of a return to acceleration in car sales. The greatest advantage a private investor has is patience.