Weekly Thematic

The 4th Second Derivative – Focus on Autos
March 20, 2020
Companies Mentioned:
Dow, Volvo, Caterpillar, Deere, Vulcan Materials, Carmax, Autonation, Lear, Johnson Controls, PPG, Axalta, DuPont, BASF, McKinsey, IHSMarkit, Verisk, Sealed Air, Berry Plastics
Commodities Mentioned:
Subjects Covered:
Autos and Auto Loans, Q1 Results, Q2 Challenges, Infrastructure/Rails, The Right Proxy, Inventory in China, Energy/Gasoline, Consumer Durables, Consulting/Data Providers, Household Products

The 4th Second Derivative – Focus on Autos

Every week we scan the reporting, news flow, fundamentals and profitability of the chemical industry and publish our findings every day. This report is primarily designed for our institutional investor clients and looks for “read-through” for other industries from what we have uncovered. The goal is to publish once a week and only on issues that are relevant.

We are a couple of days late this week – partly because of a need to digest the volume of data and the rapid changes.

 The Wrong Economic Model – The Major Auto Risk

Maybe it is age showing through here, but we believe that companies, investors and especially market commentators are using the wrong model.  The focus is on 2008, and you see charts comparing the market loss with that of 2008 and the VIX with that of 2008, showing that we have hit the same magnitude and suggesting that everything is priced in. 

While these opinions might be correct, we do not believe that there are many similarities to 2008 and that the comparison is short-sighted, and misleading.  The global recession of the early 80s is perhaps more representative, but also not a good base, because at that time we had extremely high interest rates all around the world and the economic weakness was driven by inflation partly driven by a rapid increase in energy prices.  We do think that the early 80s is a better proxy for chemical and other manufactured product demand – just in a more compressed period.  There were three years of successive global chemical demand declines in the early 80s with the total percentage drop 50% higher than in 2008.  We think that is what you will see in 2020, compressed into two or maybe three very bad quarters.

In 2008 we saw a dramatic decline in US Auto sales – and something similar in Europe.  With the expected rise in unemployment in the developed world, not only are we likely to see a collapse in auto demand that makes 2008 look like a good year, but we may also see the auto credit bubble burst.  Governments are stepping in to prevent people losing their homes, but they are unlikely to step in to protect “nice to haves” like cars in an organized manner.  They may prevent auto lenders from foreclosing and taking vehicles back, but the pain is likely to be felt by the lenders.  If this turns into an ugly mess, we may see a permanent dent in demand for car financing as the consumer becomes more conservative and lenders more leery. 

More generally, the size of the government bailouts with respect to both vital industries and the consumer, will likely impact government and consumer behavior going forward.  One of the issues that COVID-19 is highlighting is the lack of any cash safety net at the average family.  This is in part because credit has become so easily available – partly because of low interest rate – and partly because with so many years of economic expansion, a “safety net” has not been needed.  One way to build a cash reserve is to spend less on a vehicle – either downsize or change vehicles less frequently.  The “spend everything” mentality of the last decade, may have helped economic growth, but governments are paying for it now with the bail outs, it will be interesting to see whether credit is as easy to get on the other side of this.

Another point that is worthy of reflection with respect to Auto’s is that newer cars are much better made and have much longer life expectancies – if you can now buy a car with 6-year credit terms (something that would not have been possible 10 years ago with the frequency it is offered today) – there is clearly an expectation that the car will last that long.  It is not a crazy idea that auto sales in Europe and the US could fall by 50% for the rest of the year.

  • We would be very leery of companies exposed to auto loans
  • Any auto seller – like Carmax and Auto Nation
  • The auto makers themselves – even with a bail-out.
  • The auto suppliers; Companies like Lear and Johnson Controls as well as the chemical companies very levered to Autos – PPG, Axalta, DuPont, BASF and many others.
  • We see no reason why Europe should be any different.
  • We would also be concerned about a rise in personal bankruptcies, perhaps driven by auto loan exposure, despite the bails-outs.
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