auto inventories

I’m not a big fan of the auto manufacturing industry.  It’s highly cyclical and capital-intensive.  It’s plagued by chronic overcapacity and generally terrible management.  Much of the technology involved in making cars has migrated over the years to component manufacturers, making it harder for brands to differentiate themselves from one another.  On top of that, the industry employs so many people that national politics can play a large role in how it fares.  Just look at GM.

Despite all this, the industry does have its moments.  I’ll confess to, at one time or another, having owned shares in Peugeot, Nissan, Toyota, Honda, Porsche, VW, Hyundai and BYD–plus bunches of parts manufacturers and the occasional regional Asian car distributor. Today I even own a tiny position in Tesla–thanks to the encouragement of my younger son and one of my brothers-in-law (I haven’t done any of the serious work, so this is not an endorsement of TSLA.  The Wall Street consensus for TSLA earnings in the year ahead is $1.50, meaning that the stock is trading at 100x.  That estimate is doubtless wildly wrong.  The investment issue is whether it’s too high or too low.)

Let me switch from incipient anti-commodity industry diatribery to the current auto inventory situation in the US.  I think I know what’s going on.

Take Ford (F).

During 3Q13, US wholesale (i.e., sales to car dealers) unit car volume was up by 16%, or about 216,00 cars, year-on-year for F.  That increase pushed operating profit from auto sales up by a whopping 61%, after subtracting special charges from this year’s figure (the relevant information is on page 51 of the 10-Q).

Unit profit per car averaged $1,354 during 3Q12, $1,877 per car in 3Q13.  Yes, a difference  …but what’s $500?  Where’s the operating leverage?

Look at the data in a different way.  If we ask what the unit profit was on the incremental volume in 2013, the answer is $5,100 a pop.  In other words, once F’s sales covered fixed costs and reached 2012 production levels, the unit profit on anything above that was about 4x the average.  This is where the operating leverage is.

This implies

…the loss incurred if a customer leaves a Ford dealership without buying because the car he wants isn’t in stock is much higher than normal for F today.  That customer isn’t going to come back; he’s probably going to buy a Honda instead.  Given that the cost of financing dealer inventory is basically zero, it makes no sense, either for F or for the dealer, to skimp on what’s on the dealers’ lots.  Especially as early in the model year as we are now.

Yes, there may be trouble down the road from too-large inventories at some point.  But if the industry dials back production from the current 90% of capacity to, say, 80%, maybe there won’t be.  For F at least, the cost of some manufacturing downtime early next year will likely be dwarfed by the extra profits being achieved at present.

That’s what the media is missing.  On the other hand, that information isn’t sound-byty, and it’s on page 51 of a 79-page, small-print 10-Q.  No reporter or academic is going to bother looking that deeply.

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