The Next Tire To Drop On The US Economy

Auto sales in the US have been hopping for the last few years, and production has soared, and exuberance along with it, and there were even hopes that sales would soon be where they’d been before the crisis, before the bankruptcies, the plant closures, the job destruction, the bailouts. Through August, it looked like it could happen. August sales hit a seasonally adjusted annual rate (SAAR) of 16.09 million new vehicles (Motor Intelligence), which is close to where sales had been before the crisis.

The auto industry plays an outsized role in the US economy, in manufacturing, services, and retail (accounting for nearly 20% of total retail sales). Booming production and sales have been pushing economic growth when hardly anything else was.

Then came September and October and the government shutdown and the taper or whatever, and the SAAR dropped to just over 15 million vehicles in both months, and unsold inventories piled up. But it wasn’t time to get nervous. It would be just a blip. Sure enough, in November, sales jumped to a rate of 16.4 million units, and everyone breathed a sigh of relief: there’d be no slowdown; the party would go on.

Then the December debacle happened. Inventories were already high when sales dropped to a SAAR of 15.4 million vehicles. It brought actual sales for the year down to 15.6 million units. This time they blamed the snowstorms and the polar vortex and whatever, and true, no one in his or her right mind goes out to buy a car during a snow storm, but snowstorms happen every winter, and the weather was beautiful in other parts of the country, including much of the West Coast.

But never mind. The Detroit Auto Show is happening, and exuberance is boiling over. GM promised to pay a dividend. Tesla goosed its stock price with another one of its announcements. Ford stirred up excitement with visions of an aluminum-framed F-150. And gleaming models were on display, and industry insiders were cranking out hype at 80 mph.

Then AutoNation CEO Mike Jackson poured cold water on it all. He should know. He runs the largest chain of dealerships in the country, an empire of 225 stores that sold 296,419 new retail units in 2013, about 2.24% of total US retail sales. He warned about the out-of-whack inventories.

Dealers were sitting on $100 billion in new vehicles – which automakers had already recognized as sales on their books. Channel stuffing. There were 3.45 million units waiting to be sold. While sixty days’ supply would be “an accepted inventory figure,” as he said, current levels are far above it. The figures were even worse with fleet sales taken out of the equation. He put his finger where it hurts, where it has always hurt.

Fleet sales can be a profit sinkhole. They’re in the infamous category of “but we’ll make it up with volume.” Ford was Number One in that dubious category, with 707,000 fleet units, or 28% of its total sales. GM sold 653,100 fleet units, or 23% of its total sales. Chrysler 22%, Toyota 9%, Hyundai-Kia 15%, Nissan 14%, and Honda 2% – it only sold 30,400 fleet units. Combined, these top seven sold 2.35 million fleet units in 2013, or 15% of total sales.

With fleet sales, Ford made it to Number Two in the US. Based on retail sales only, Toyota was Number Two, beating Ford by 262,000 units! That’s one of the reasons why Ford and GM and others are doing it: bragging rights.

Fleet units largely bypass dealer inventories. Once fleet sales are taken out of the equation so that only retail sales count, inventories suddenly look enormously bloated, with 90 to 120 days’ supply, Jackson pointed out.

And now sales have started to slow down. The bane of the industry. In addition, January and February are usually the slowest months of the year, and they’re starting out with bloated inventories. Unless a miracle happens, they’ll end up with even more bloated inventories.

Automakers and dealers are already reacting, Jackson said. Discounts are rising, and automakers have started paying dealers for hitting monthly sales targets. But that won’t be enough. Rebates and other incentives will be next. The chances of an all-out discount war, the kind that tore up automakers before the crisis, are fifty-fifty, he said.

“What I’m saying is you’re on the edge of a slippery slope and even sliding down it a bit,” he said. “It’s a risk.”

Unperturbed, automakers are producing cars like hotcakes. Exuberance leaves no room for a slowdown. And over the next few years, they’re even boosting annual production capacity in North America by over one million vehicles!

GM, Ford, Toyota, and Honda are expanding existing plants in the US and Canada. Nissan just put a new plant on line in Mexico. Volkswagen, Honda, and Mazda are building new plants in Mexico. Volkswagen said that it would build another new plant in North America. And its plant in Tennessee is operating at half of its capacity. But who the heck is going to buy all these cars?

“The last thing we need is to get bricks-and-mortar capacity increased,” warned Chrysler and Fiat CEO Sergio Marchionne.

The devastating crisis in the industry was caused by years of overcapacity, overproduction, steep rebates, hollowed-out balance sheets, bloated inventories, and a host of other problems that suddenly came in contact with crashing sales. This experience taught the industry to not ever lose sight of that vaunted “discipline.” The industry would never again be blinded by exuberance. But that lesson has already been forgotten.

Slowing sales and ballooning inventories are a toxic mix in the auto industry. With production and import schedules set way in advance, there is no way to suddenly turn off the spigot. Instead, automakers and dealers will have to figure out how to get rid of those vehicles piling up on their lots and coming down the pike. Large incentives would help, but they’d bleed profits from automakers – something they’d promised to not ever do again. And once the industry has become addicted to the incentives, it’s nearly impossible, as the industry consistently re-found out, to stop them.

Given the size of the car business in the US economy, even a minor squiggle will be noticed. In the best-case scenario, sales would accelerate sharply without too much discounting, and it would eat up excess inventories. If that doesn’t happen, there’d have to be big discounts and rebates and other incentives. They’d bleed the automakers, and eventually they’d have to cut production, and overtime would be eliminated and then entire shifts, and people would be furloughed, and so the industry that consistently outperformed over the last few years and pushed manufacturing and consumer spending forward and caused economic growth to tick up would suddenly be a big drag on the economy.

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