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.
Larson: Now, some might argue that fewer people are driving cars, because they maybe don't have the means to purchase a vehicle and also miles driven has gone down slightly in the last couple of years related to fuel prices, will these things affect this expected rebound in sales?
Guziec: Those factors are true. Miles driven has fallen off a little bit. Some of that I attribute to just unemployment. An unemployed person drives fewer miles than an employed person. But at the end of the day to make a material shift from cars as the primary mode of transportation to and from work, grocery store, et cetera, to public transportation would require a massive infrastructure build in public transportation. I mean, it just isn't feasible for people in big scale, on a scale that would affect overall sales, to make that shift. So, yes, the effect is there, but the wear and tear of vehicles and the wear-out of vehicles really dominates in the long run.
Larson: And what do the demographics tell you?
Guziec: Well, the demographics, if we just look at the amount of the population between 15 and 79, which is the best number we have, about 90% of that population is licensed to drive, and it's been like that for about 20 years.
And if we project that forward, that's how we get to our 17.4 million units a year is the new licensed drivers that are coming on purchasing a vehicle, which eventually happens for most of the population, plus the existing drivers replacing their vehicles after about 14 years, 7% replacement rate means about a 14 year, a little over a lifespan.
Larson: So if one believes in this cyclical rebound, very significant rebound in auto sales that will be happening over the next couple of years, what are some names that we can consider buying in order to play this?
Guziec: Well, anything related to the domestic auto industry is potentially interesting, and that means the auto manufacturers, the auto suppliers, and the auto dealership groups--but the auto manufacturers and suppliers probably have the highest leverage, operating leverage to a growth in sales. So if sales at Ford, for example, were to double, its operating profit would probably go up four times or more.
So, you know, across the industry, just about every name, if you believe this thesis and you believe that we are going to go ... Our normalized scenario based on ... the current consensus drop in unemployment rate, is to get over 20 million units a year, almost 21 million units a year at some point, and that will sell 96 million units over the next five years. And we can say that with more confidence because we can't exactly time when the rebound is going to happen.
If you believe that kind of scenario, just about anything that's in the auto space is not pricing that in, and anything that's directly related to the U.S. domestic auto industry is a good buy.
Larson: Well, Phil, I am personally glad to hear that past is not prologue in the auto industry. So thanks for coming.
Guziec: Thanks for having me, Paul.
Larson: I am Paul Larson.