New Vehicle Platforms Buffer Hard Times

(Export Development Canada – Peter G. Hall)

In any economic slowdown, big-ticket purchases are the first target of penny-pinching consumers. Auto producers know this well, and are feeling the squeeze. Sales are down sharply in the U.S., by far the world’s largest auto market, raising serious questions about the industry’s prospects.

Spending on autos and auto parts accounts for about 4% of U.S. GDP. That’s a lot of economic clout in the world’s top economy – and a big drag on growth when markets head south. In September, vehicle sales were down 23% from year-ago levels, and falling. Second-quarter data show that the auto sector alone chopped 0.6% from economy-wide growth during the period, the fourth successive quarterly decline, and the deepest thus far. Is there more bad news in store?

The past few years hold valuable clues to the answer. Sales are estimated to have exceeded underlying demand for eight of the past ten years, thanks to the strong economy, easy credit conditions and consumers that were all too willing to spend. Moreover, easy payment terms helped to extend the sales cycle – normally about 8 years – by 6 additional years. During this time, the number of registered vehicles surpassed the population of driving age for the first time in U.S. history. In this light, the correction was overdue.

But the sharpness of the correction is unusual. Hold sales steady for the rest of the year, and the annual decline is over 14%, the largest single-year drop since 1980. Why? Tighter credit markets are putting an additional bite on sales, as financing costs have risen. Weaker company earnings have curtailed producer incentives, a big factor in the heady sales days. And declining resale values have put the bite on leasing activity, which was an affordable option for many consumers.

Rising oil prices have also played their part. American consumers are driving much less than they did last year, reducing the need for vehicles, and the depreciation on vehicles being used. High fuel prices are also spurring substitution toward more energy-efficient models, favouring imported brands over traditional North American cars and trucks. So far, the prognosis is not heartening.

But the rapid recoil of U.S. sales has a silver lining: the faster sales levels correct, the quicker the excesses of the past will be worked off. In fact, the market may already have bottomed out. At the current sales pace, excesses would be run down enough by mid-2009 to raise sales in the second half of the year, setting the stage for strong performance in the next two years. Although it still implies a decline in 2009, it’s more than can be said for the stressed U.S. housing market.

Canada’s auto sector is feeling the pain of current U.S. conditions, with unit production sustaining a double-digit decline this year. All things equal, 2009 would look quite similar. However, new products coming onstream will save the day. No less than six new models will be introduced or ramped up, enough to offset declines in established brands completely. Good timing, indeed.

The bottom line? The auto sector is always particularly vulnerable to the economic cycle, and this time around is no exception. U.S. sales will be slow for much of 2009, and Canada’s producers will be affected. Those attached to new products will fare better, and may even see growth.