Is There An Auto Bubble?

By: Chad Hudson | Wed, Sep 4, 2002
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Auto sales went through the roof during August. Car sales jumped 3.3% to 18.7 million in August from July's 18.1 million and 14% from a year ago. August was the fifth strongest month ever. Just for the record, here is a table of the five biggest months for vehicle sales.

Month Millions of units
Oct 2001 21.3
Oct 1986 21.2
Feb 2000 19.2
Sept 1985 18.8
Aug 2002 18.7

There is little doubt that zero-percent financing and other incentives from the automakers are having a dramatic effect on sales. General Motors announced today that it will maintain the zero-percent incentives. Other automakers were quick to affirm they would as well. As the low cost producer, it appears GM is simply trying to drive Ford and Chrysler out of business. In fact, it is starting to resemble a car bubble. p

The automakers are adding capacity, raising production, and aggressively marketing to grab or maintain market share. Wasn't "market share" the battle cry for the telecom equipment makers? How are these companies going to be positioned once car sales decline? These companies have such massive fixed costs that it is better for them to sell cars at cost than to idle their plants. The aggressive marketing schemes have slashed GM's profit per car. Last year, General Motors only made about $337 per vehicle. At least it made money. Ford and Chrysler lost over $1000 per vehicle they sold. Japanese makers have been able to report record sales without sacrificing profits. Honda, Toyota and Nissan all maintained its profits per vehicle over $1,000, with Honda leading the pack last year making $1,661 per vehicle last year. In 1999 it was GM that lagged the Big 3 when it made $853 per vehicle. Ford ledthe Big 3 by earning $1,735 per vehicle in 1999. It is amazing to see Ford expected to earn only $0.30 this year and only $0.80 next year when car sales are running at a record pace.

Here is a table of August auto sales:

Automaker Aug. Sales Growth Notes
GM +18.2% Increased production
Ford +8.2% Best month this year
Chrysler +23.6% 2nd best August ever
Audi -0.4%  
BMW +12.9%  
Honda +12.9% Best month ever
Hyundai +12.6% "All-time record month"
Jaguar +56.2%  
Kia -2.4% "Strongest August ever"
Land Rover +58.8%  
Mazda +36.1% Best month since 1995
Mercedes -3.0%  
Mitsubishi +6.3% Best August ever
Nissan +19.8% Infinity - best August ever
Porsche +3.5% 2nd best month ever for 911
Saab -7.0%  
Subaru +4.2% 2nd best month since 1987
Toyota +13.2% Best month ever
Volkswagen -13.3%  
Volvo -15.3% 2nd best August ever

Maybe cars are the only items consumers are buying. Retail sales fell again last week according the Instinet Research Redbook weekly same-store sales report. The 0.2% decline in same store is the second decline in three weeks, only broken up by last week's 0.0% gain. Additionally, the report said August sales declined 1.7% from July. Most economists expect consumers to slow down at some point; they were just hoping that it would coincide with a pick up in businesses spending. Unfortunately, it appears it might happen at the same time as the manufacturing sector begins to head down again, along with technology.

The ISM report showed the manufacturing sector is showing signs of contracting again. While the PMI was 50.5, which indicated the manufacturing sector continued to expand, new orders declined for the first time in nine months. The survey also showed that backlogs declined for a second month and employment continues to contract. The employment component of the ISM report has contracted for 23 consecutive months.

The employment situation continues to be a thorn in the recovery hopes. Last week initial jobless claims rose 2% and topped 400,000 again. This marked the fourth consecutive increase and prospects do not point to a strong turn around. Last week we mentioned the 50% surge in mass layoffs reported by the Bureau of Labor. This week Challenger, Gray & Christmas revealed that companies announced 118,067 layoffs in August, a 46% jump from July. September started off with a bang. The bankruptcy of Consolidated Freightways puts over 15,000 workers out of a job. The future is also appears dim. According to last week's Manpower survey, only 24% of companies anticipate adding workers to their payrolls. This is lower than the 27% that expected to add workers during the third quarter and the same number as last year. The number of companies planning to reduce jobs also increased from the third quarter. Eleven percent of companies are expected to trim their workforce, compared to only 9% for the third quarter.

I hate predicting economic data, but with the abundance of negative news regarding the employment situation, expectations for Friday's nonfarm payrolls report seems a bit optimistic. Economists are expecting an increase of 30,000 jobs. If that happens, it would be the second best employment report since February 2001.

The labor dispute between West Coast port workers and shipping companies continues into a second month. According to a few recent reports, it sounds like it is not progressing. In fact, there is more and more talk about a possible work slowdown. Since the U.S. is dependent on imports, any disruption by the port workers could cause turmoil throughout the economy. We do not have any insight on whether a strike will occur or not, but it is definitely a situation that investors should be monitoring, as there is a lot more downside if workers strike than upside if the situation is resolved.

With the recovery in technology being continually delayed, analysts have been lowering their estimates on Intel. Analysts are expecting Intel to guide financial forecasts lower during Thursday's mid-quarter update. Today, Merrill Lynch lowered its earnings estimates. In the research note, Joe Osha said, "Despite the stock's attractively low valuation on price/revenue and price/book, on earnings Intel still only looks fairly valued." Currently Intel is valued at about 33 times earnings, 3 times book value and 4 times revenue. Intel's price-to-sales ratio is still substantially above where it traded in the early 1990s and I highly doubt anyone considers its book value when evaluating Intel. Additionally, I think Intel's book value is not the best gauge to value the company. What is a semiconductor fab worth to someone else?

The weak economy is raising havoc with state and municipal budgets. California finally passed its budget, only 61-days late. For the first time since 1992-93, California's spending plan is lower than the prior year. The budget has several critics that make is sound like the State has taken a page out of Wall Street's playbook. California was able to avoid the difficult decisions of cutting spending or tax increases, instead it is relying on several one-time measures. The state is borrowing against anticipated revenue from the national tobacco settlement, temporarily ending a business tax credit and restructuring the bond debt. Governor Davis noted that capital gains tax collections will decline to $6 billion to $7 billion this year, far below the $17 billion the state enjoyed during the booming stock market. If the economy continues to languish for another year, California along with several other states will have to start making the difficult decisions. According to Jean Ross of the California Budget Project, "the agreement traded a real tax increase for a variety of illusory savings. They are raiding every cookie jar in the state and borrowing every way they can."

The ongoing difficulties state and local governments are experiencing could be the next sector to experience weakness. From reading several stories, several states are doing everything they can to avoid the tough decisions. Part of that could be that it is an election year. If the economy has not rebounded by next year, there will have to be a lot of tough decisions made by a lot of state and local governments.

Now that Labor Day has come, Wall Street will get back to work. We would not be surprised if analysts started lowering EPS estimates for the third quarter. Last week, Chuck Hill, director of research for FirstCall, said he expects earnings estimates to continuing falling into earnings season. Currently, analysts are calling for third quarter earnings to be 11.2%. This is about a third less than the 16.6% growth expected at the beginning of the quarters, but Hill expects this to get revised all the way down to 6% growth. He then expects companies to beat the reduced earnings estimates, with the S&P 500 posting 8% earnings growth for the third quarter.

The economy is certainly at a crossroads. The next month should shed light on which direction the economy will head for the remainder of the year. At this point there is not a lot of positive catalysts. If the economy does not pick up, there is little reason to think investors will continue to pay 18 times this year's estimated earnings. Estimates that will obviously come down if the economy falters.


Chad Hudson

Author: Chad Hudson

Chad Hudson
Mid-Week Analysis

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