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Cloudy Outlook: Market Insiders Offer Their Prediction for 2011

The industry is facing another possible crisis, but nobody seems to be in panic mode just yet.

June 2011, F&I and Showroom - Feature

by Gregory Arroyo - Also by this author

Dealerships like Randy Martin’s Dick Dyer Toyota saw some of its best incentives pulled for the month of May in reaction to Toyota’s initial production estimates. Two weeks later, however, incentives were back.
Dealerships like Randy Martin’s Dick Dyer Toyota saw some of its best incentives pulled for the month of May in reaction to Toyota’s initial production estimates. Two weeks later, however, incentives were back.

Randy Martin, an Internet manager at Columbia, S.C.’s Dick Dyer Toyota, says that May started out with a practically empty incentive sheet. But by the middle of the month, Toyota began offering subvented rates and special leases on several models. It’s not dealer cash like he wanted, but it’s something.

“We were informed in April that we’d see a lot less incentives and inventory,” Martin says. “We were told it would be that way for the next three months.”

Martin’s initial concern was that a cut in incentives might drive customers to other brands, which was an encouraging prospect for Bill Pearson’s single-point Ford store in Peoria, Ill. But it’s Pearson’s used-vehicle department that has him excited. “National statistics show that there are four used customers to one new, so there’s high demand for used vehicles,” he says. “Some of that has to do with the economy, some of it has to do with fuel economy and some of it has to do with what happened in Japan.”

Paul Taylor, the NADA’s chief economist, says the industry was facing a post-World War II situation following the March 11 earthquake and ensuing tsunami that struck Japan. The year was 1945, and vehicle production facilities were either wiped out or needed to be reconverted from wartime-goods makers to car producers.

“That was the last time we faced a situation where the supply side of the market was restrictive,” Taylor says. “Of course, the pressure was higher then, because the capacity for vehicle production in Europe and Japan had largely been destroyed.”

Market watchers like Taylor see a rough summer ahead. Come September, however, it’s anyone’s guess what the market will look like for the rest of the year and beyond.

The situation was fluid in the weeks following the March 11 disaster in Japan. Toyota initially said it would take until June before production levels returned to 70 percent capacity, but the news brightened in late May when the company raised its projections to 90 percent in late May.
The situation was fluid in the weeks following the March 11 disaster in Japan. Toyota initially said it would take until June before production levels returned to 70 percent capacity, but the news brightened in late May when the company raised its projections to 90 percent in late May.

A New Paradigm

Analysts estimate that the disaster in Japan will result in the loss of 300,000 to 400,000 new vehicles. But U.S. dealers are now selling three used for every new vehicle sold, according to TrueCar.com, so most analysts believe the used market will feel the pressure the most.

“I think July and August is when that pipeline is really going to dry up,” says Black Book Managing Editor Ricky Beggs. “The speculation will be, ‘Do I go ahead and buy used cars now, hold onto them for 30, 60, 90 days so when I don’t have new, I’ll at least have used product to sell?’”

Complicating matters are gas prices, which increased by 37 percent from January to April. The concern is that rising prices will cause dealers to unload gas guzzlers in a panic like they did in July 2008, when the U.S. average price for regular gasoline hit an all-time high of $4.11 per gallon and wholesale prices on used trucks and SUVs plummeted by about $12,000 virtually overnight.

May data from AuctionNet, a wholesale auction database, showed that supplies of SUVs, large pickups and intermediate compacts at auction were down 17, 40 and 26 percent, respectively. Jonathan Banks, who manages the NADA Used Car Guide’s data and editorial services, says that’s an indication that dealers aren’t dumping vehicles in a panic.

That could change if gas prices hit $4.50 a gallon. Taylor, however, says recent evidence shows that prices could fall to $3.80 a gallon, which would allow manufacturers to sell their full range of vehicles, including higher-valued vehicles like SUVs and trucks.

Also encouraging is the credit situation. As of March, average loan amounts generated through auto finance companies were up 88 percent over 2009, according to Equifax. “What we’re seeing is a number of loans across different segments increasing,” notes Michael Koukounas, a senior executive with Equifax. “They’re not increasing to pre-recession levels, but they’re increasing in general, and automotive is one of the industries leading the way.”

Koukounas attributes the increase to automakers being able to get more for their products, a belief supported by recent incentive data from Edmunds.com. In April, average incentive spending per new vehicle sold fell to its lowest point since October 2005. The NADA’s Banks attributes that to the industry’s new reality.

“I call it a new paradigm, because we had real strong diligence on the new-car side in terms of production and sales, which kind of lowered incentives and kept supply and demand in check,” he says. “And everyone was able to be profitable at these lower sales levels because we’re selling more vehicles on a pull-type basis.”

But this new reality also has made the market more sensitive to shocks to the system, as was seen following the Japan disaster. Wholesale prices for intermediate compacts increased 10 percent in March and should have, at most, remained flat for April. Instead, prices increased another 6 percent after Toyota and Honda announced that dealer allocations would be at about 50 percent for May and June.

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