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Incentives threaten auto stocks
Sure they boost sales, but that simply means people will buy fewer 2006 models. GM and Ford shares may fall toward their 52-week lows.
By Robert Walberg
Seduced by the high of record monthly sales, the Big Three automakers have become addicted to incentives. Like most addictions, this one isn't healthy for the industry. And investors who've been lured in to the auto stocks by rising sales may want to walk away now.
Though Ford Motor (F, news, msgs) led the group with a 35.5% year-over-year sales gain in July, the company's refusal to let go of the employee discount pricing program means that profit margins and overall profits will suffer for at least another couple of quarters. The same can be said for General Motors (GM, news, msgs) and DaimlerChrysler (DCX, news, msgs) because they extended their employee-discount programs on 2005 models through Labor Day.
For the record, DaimlerChrysler enjoyed its best single month ever, with sales jumping 32% over last July, while General Motors saw a 19% sales gain. It should be noted that this was the second month of discounting for GM, while it was the first month for Ford and Chrysler. Overall, the July numbers translated into a seasonally adjusted annual rate of 20.86 million vehicles. According to research firm Autodata, this was the highest seasonally adjusted annual rate since October 2001's rate of 21.8 million.
Not surprisingly, the big October 2001 numbers were a direct result of General Motors' decision to launch its zero-percent financing program (with Detroit's other car makers following suit) in response to fears that the Sept. 11, 2001, terrorist attacks would cripple the economy. But just as the automakers suffered a subsequent slowdown in sales once that financing program ran its course, so to will the Big Three experience another slowdown once the employee-discount programs are terminated.
A poor substitution
That's the problem with the current strategy. It substitutes short-term sales gains for long-term profitability. And if there's one thing the beleaguered auto industry can ill afford it's to do more damage to its profit potential.
Proponents of the current incentive program note that all the companies are doing is clearing out 2005 inventories and positioning the industry for a strong transition to 2006 models. This is especially true for GM, which is launching a series of new models after struggling with a stale, outdated, copycat lineup this year.
Related news and commentary on MSN Money
No doubt the employee discount program has created a car-buying frenzy among consumers, but the hopes that it'll set up the new model year for success is folly. Instead, by posting huge sales in June and July the industry is stealing sales from the future. At least one auto forecasting company has predicted that the incentive programs have caused the sale of 200,000 vehicles to occur now rather than later this year. And those later sales would include new, redesigned, higher-priced 2006 cars.
Pushing consumers into outdated brands also runs the risk of poor customer satisfaction down the road, another problem the domestic auto companies can ill afford since they've been steadily losing market share to foreign companies. One reason is that the foreign automakers have a reputation for producing higher-quality vehicles. Investors should note that even though GM posted strong sales again in July, the company saw its share of the U.S. market decline to 29% from 29.2%.
A pair of khakis with your car?
But the biggest problem facing the industry isn't the cannibalization of future sales or the threat to customer satisfaction. It's the continued conditioning of U.S. consumers to discounting. GM is becoming the Gap (GPS, news, msgs) of the auto industry -- customers know if they wait long enough the merchandise will go on sale. In fact, according to Kelly Blue Book, more than 70% of U.S. consumers use rebate programs to determine when they buy a car.
This could be a serious problem for the upcoming year. Ford and GM already have announced that many of their 2006 models will carry lower sticker prices than the 2005 models. The sticker prices for 2006, while lower, are still higher than the price the companies were receiving on the 2005 models, less rebates. So in theory, the potential is there for improved margins and higher profits.
Unfortunately, with consumers conditioned to wait for incentives before they pull the trigger, Ford and GM run the risk of having to add promotions to already reduced prices, resulting in even lower margins and lower profits than in 2005.
Given the rise in the stock prices of the Big Three over the past couple of months, it appears investors are also being seduced by the big sales gains generated from the incentive program. That would be a big mistake, however, as the day of reckoning is fast approaching. And when it comes, we could be looking at a new round of 52-week lows.
At the time of publication, Robert Walberg neither owned nor controlled shares in any equities mentioned in this column.
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