Auto loans could become more expensive as car prices fall, analyst says
Seth Basham covers hard retailers for Wedbush Securities, including auto dealers and auto parts chains. Barron’s spoke with him recently about how these companies will fare during the pandemic and the expected recovery. His edited comments follow.
On the resumption of the purchase of cars:
As we move past these [Covid-19 lockdown] mandates, I think demand will improve, but it may not return to where it was before. People won’t have as many places to go if they don’t have jobs, and commuter miles are a major demand generator for auto transportation. Likewise, they won’t be doing so many social events and so many trips. So this will have a ripple effect that will persist at least until the end of 2020.
People who bought very expensive new cars could switch to new more moderately priced cars. Suddenly, people who were buying new, cheaper cars could switch to newer model used cars, and so on. This will cause a change in the makeup of new and used cars that are sold.
On the purchase of electric cars:
[Drivers will] probably be a little less willing, given the additional cost. And second, if oil prices remain depressed, the economic advantage of purchasing electric vehicles over gasoline vehicles is not as strong.
On used car prices:
What we are seeing now is that new car prices are under pressure after years of strong increases. And this pressure is fueled by higher incentives in terms of financing [manufacturers]. This translates into lower prices for used cars. By some estimates, used car prices are falling by up to 10%. It is a rapid and precipitous decline that we have never seen.
On the supply of used cars:
We are seeing auto dealers who have a lot of inventory on hand start trying to get it out. As we move forward, production levels on the new car side should adjust and price pressure on the used car side should ease as well. So I don’t think it’s going to be as bad as it looks right now, when we get to the middle, the end of summer.
On the automotive financing sector:
We are likely to see increased losses on subprime auto loans. Bad debts are already starting to increase. We hear about extensions and abstentions. Now, even going back to the Great Recession, we’ve never seen a widespread default, so to speak, in auto loan securitizations. They are fairly well guaranteed. At the moment, it is difficult to predict whether or not we will see losses for investors in these types of securities in this environment. At this point, we don’t believe this is the case. But this will lead to a serious tightening of credit conditions for new loans, especially on the subprime side, but to some extent also on the premium side. It will therefore cost more to borrow to buy a car. And this despite the fact that we are seeing a decline in benchmark interest rates.
On auto parts chains:
Historically, they have behaved somewhat counter-cyclically in times of economic downturn, as around 85% of what they sell is due to breakdowns and vehicle maintenance, with the remaining 15% or so being more discretionary items. . What we are seeing in this environment is unprecedented, as very few cars are currently on the road. Kilometers driven have fallen by as much as 70% in some major metropolitan areas in the United States. The demand for parts for breakdowns and even maintenance has fallen off a cliff. Although these stores remain open, we are seeing a downward trend in sales of around 30%.
As we go along, it’s clear that if people start driving more frequently, we’ll see sales trends improve. As we move forward through the summer, we certainly expect a downturn to start to benefit these companies. And that reduction effect is that people keep their existing vehicles longer and do more repairs themselves instead of having others do them for them. These guys are expected to see higher sales by the end of 2020 to the start of 2021. And in fact, if you go back to the Great Recession, we’ve seen it. It took a few quarters for these guys to start seeing an improvement in sales trends, but they definitely did. And that happened long before we saw an increase in sales trends for most discretionary retailers.
One of our favorite names is
(symbol: AZO). About 80% of their sales go to DIY enthusiasts and 20% to garages that repair cars on behalf of consumers. This reduction effect will be very beneficial to them. They also have the record and the means to support a fairly pronounced immediate slowdown.
On car dealers:
(KMX) is a name we are warming to given the fact that we believe they will come out of this crisis a stronger company compared to many of the competitors who are going to be weakened or potentially end up going bankrupt. . They should therefore be able to gain market share. [Smaller used-car dealers] have relatively high fixed costs with a sharp drop in sales as well as pressure on the value of the vehicles they have. Frankly, some of the smaller ones [new-car] dealers can also be in the same boat. We have seen good consolidation following the Great Recession. I think we might see more of it coming out.