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By Paul A. Larson | 09-02-2010 04:43 PM

Auto Sales Set to Kick Into Gear

A pent-up demand is building in the auto industry that the markets don't seem to have priced into domestic auto-related stocks, says Morningstar's Phil Guziec.

Paul Larson: Hi, I am Paul Larson, editor of Morningstar StockInvestor.

With me today is Morningstar OptionInvestor editor Phil Guziec, who has written a very interesting piece on auto sales that we are going to run excerpts from in the September StockInvestor.

Thanks for coming, Phil.

Phil Guziec: Thanks for having me, Paul.

Larson: So to give people some context, what has been happening with auto sales over the last decade or so?

Guziec: Well, auto sales have been unusually consistently strong up until the beginning of the Great Recession. A strong economy and growth in the number of drivers, relatively low fuel prices have led to strong vehicle sales. And then, as we went into the September 11th period, we had excess U.S. auto manufacturer capacity, and the manufacturers didn't want to shut down production, so they started into a price war in the late 90s, early 2000s and it really got the high gear with the Keep America Rolling campaign that GM kicked off right after September 11th, and that lasted almost through the beginning of the Great Recession. So basically, we stuffed a lot of vehicles out there.

Larson: So in terms of numbers, how high of a sales peak did we actually get and then how far down the trough have we gone?

Guziec: Well, we were up to a little over 17 million units a year, and we hovered in that range from the beginning of the 2000s up until '06. And now, we're running at 10.5 million to 11.5 million units a year in light vehicle sales.

Larson: So what are your projections for auto sales both in the short and in the long term?

Guziec: Well, it's hard to make a projection in the short term, specifically related to timing. But the interesting thing about auto sales is in the short run, they are determined by psychology and pricing and all the things that normally make consumers decide to buy discretionary goods. But in the long run, a car is a consumable good, like a pair of shoes or a set of tires for the car--it just takes it longer to wear out. So in the long run, it's the number of licensed drivers and the number of miles they drive a year that determine demand.

So normalized demand based on demographics and a normal replacement rate of vehicles, which is about 7% of existing licensed drivers replacing their vehicles in any given year, would be about 17.4 million units this year. In addition, the fact that we've run at such a low sales rate for a few years now, we've not only absorbed the excess vehicles that were kind of stuffed into the market, but we've actually built up about 10 million units of pent-up demand that have to be absorbed in addition to getting back to the normalized 17.4 million units.

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