Will Recent Recovery in Domestic Vehicle Sales Prove Sustainable?

During the first eight months of 2011, the Detroit Three auto manufacturers have enjoyed a 16% increase in unit volume as industry sales increased 10%. These results reflect, in part, an improving economy and inventory problems for two of Detroit’s primary competitors, Toyota and Honda. Detroit’s market share increased to 49% (up from 44%) while Toyota and Honda saw a combined decrease in share to 20% (from 26%). Going forward, the Detroit based manufacturers are likely to face a slowing in economic activity and resurgence from their two largest overseas based competitors. These two factors could result in pressure on both unit volume and selling price, net of incentives.

Before we begin assuming long-term growth, it is important to remember how heavily the industry demand may be affected by future interest rate increases. While current interest rates are at historical lows, this may not continue. A majority of new car purchases involve some type of monthly payments, leases or installment contracts. These arrangements are highly impacted by interest rates. The variance of the rate charged can drastically alter the monthly cost of a new vehicle purchase. This, in turn, will determine whether the purchaser can realistically afford the payment.

Labor costs are also a critical part of the mix. Detroit auto companies compete, to a considerable degree, with non-union assembly facilities (often owned by overseas based companies). While recent agreements with the UAW have reduced labor costs, in part through significant reductions in the pay rate for new hires, the sustainability of a two-tier wage system remains an open question. The UAW has made it clear that bringing up entry-level pay rates is a priority in current contract negotiations.

Over the next several months it will be important to assess the new labor agreements, trends in industry sales and shifts in market share as Honda and Toyota replenish depleted inventories.

Walter J. Kirchberger, CFA