On Tuesday, during the peak of the Harvey-related flooding, we reported that the hurricane may leave a greater trail of automobile destruction than even Katrina, the most expensive natural disaster in US history. In August 2005, Katrina wiped out some 500,000-600,000 vehicles but William Armstrong of CL King warned that Houston has about 5x more people than New Orleans did at the time.
The news was especially bad for retailers and auto dealers: storms of this magnitude bring not only millions in salvage-related charge offs for the auto industry but a loss of critical “selling days” for one of the biggest markets in the country. As CNBC pointed out, Citi analyst Itay Michaeli figures Hurricane Harvey could knock about 500,000 units off the August auto SAAR to be reported tomorrow. Michaeli now estimates Harvey will affect some 125 counties in Texas and about 60 percent of the state’s auto sales.
Before Harvey, Michaeli estimated the August sales pace for the country was going to be in the mid-16 million range. As the storm lingers over the area, Michaeli has dropped his estimate. “Our analysis suggests that Hurricane Harvey could push this down to the low-16 million unit range,” Michaeli wrote in a note to clients.
“This is bad; real bad,” said Marc Cannon, an AutoNation executive vice president. “Right now, we are focused on making sure all of our employees are safe and taken care of. At the same time, we’re focusing on getting all of our stores up and running.” AutoNation’s 18 dealerships in the Houston remain shut as widespread flooding has not only swamped thousands of buildings in the Houston area, it’s likely damaged hundreds, perhaps thousands of new cars and trucks parked on dealership lots.
Which, while terrible news to dealers – many of whom face bankruptcy if their insurance policies don’t cover all the damages – may be just what the struggling U.S. OEM and supplier industry ordered, according to a new report by RBC. As bank analyst Joseph Spak writes, “while the devastation from Tropical Storm Harvey continues and our thoughts remain with the affected areas, we are beginning to wonder if the storm can, at least near-term, change the auto narrative. Harvey may have removed a number of the overhangs that caused investors to sour on the group.“
The RBC strategist then lays out his reasoning why Harvey may have helped the US auto industry in terms of the 4 most pressing narratives: bloated inventory, demand concerns, peak mix, and used vehicles pricing. In fact, as he puts it, “In short, Harvey may have solved the industry’s inventory problem.“
Here is the spin:
- Overhang 1: Bloated inventory. July 2017 days inventory stood at 68 days, 8 days higher than July 2016 and 13 days higher than the 10-year July average. This led investors to be worried about production cuts. Absolute inventory (at July 2017) was up ~330k units y/y. Edmunds estimates approximately 366k new cars and light trucks are on dealer lots in Texas that could be affected by Harvey. We believe a significant number of those could be damaged. Once Houston is stabilized, we see an opportunity for automakers to help re-position inventory from other geographies (we suspect GM could take advantage of this). In short, Harvey may have solved the industry’s inventory problem.
- Overhang 2: Demand concerns. We expect there could be a modest impact to August SAAR (we hedged by ~0.1mm to 16.4mm), but also believe the market won’t put a lot of credence into the print. We would expect a further impact into early September before delayed purchases start to come back. Then over late 2017 and into 2018, replacement would occur. The actual damage to existing vehicles in operation is unknown but likely extensive. Cox Automotive estimates ~500k vehicles could ultimately be scrapped (they estimate Sandy was ~250k). As a result, we believe future NA production forecasts could be positively revised – a good catalyst for suppliers.
- Overhang 3: Peak mix concerns. Moreover, this should be a rich mix as Texas is a key truck market (~14% of all full-size trucks, vs. 9% of overall sales; 1 out of 5 vehicles sold in Texas is a full-size truck). Key pickup truck suppliers AXL, TEN, BWA could benefit. We would favor Ford and F-150 suppliers and Ram and their suppliers over GM and K2XX suppliers given GM may not be able to participate as much given constraints from their program changeover.
- Overhang 4: Used vehicle pricing concerns. We would expect near-term used vehicle pricing to improve given a rush of demand for loaner vehicles. This could help consumers looking to trade-in vehicles and potentially residual values for new leases.
In short, yet another twist on the familiar broken window, or in this case, busted car fallacy, which of course is great in capturing the flow impact on metrics such as GDP and consumption, but completely ignores the capital lost as a result of the inherent destruction, something which insurers, and perhaps the US taxpayer, will ultimately be on the hook for. Naturally, there is only so far that this type of “obligation transfer” can stretch before the whole construct falls apart, or else every time the US entered a recession a few strategically placed nukes would be sufficient to unleash a new economic golden age until the next contraction in the business cycle. Luckily, economists haven’t gone that far yet. Unluckily, it is becoming increasingly obvious to everyone that the “next best thing” may be needed to boost growth. War.
As for cars, here is Spak’s advice on how to trade the Texas tragedy:
“Time to tactically increase auto exposure. Net, with valuations that will screen attractive relative to other potential Harvey recovery plays, we would tactically look to increase exposure to the group. Separately, suppliers with meaningful Europe exposure should benefit from the Euro move. Among suppliers, larger beneficiaries could be: AXL, BWA, DAN, TEN. For OEMs, we would look to F.”
If he is right, how long before a populist outcry demands that any industries benefiting from Harvey’s destruction should be taxed more?
For now one thing is certain – stocks of RV makers have surged on the Harvey news, whether on expectations that just like during Katrina, FEMA will splurge on recreational vehicles to house the tens of thousands of emergency workers, or simply on expectations that with their homes – and car – badly damaged, tens of thousands of Texans will opt to buy the one object that combines the two.
Which just may push US GDP even more into the green: recall that in the first quarter, the biggest contributor to personal spending came from sales of… recreational goods and vehicles.
Incidentally, for those who wonder, FEMA’s 2005 purchase of RVs ended up being a big hit to taxpayers. Back then, FEMA hurriedly bought 145,000 trailers and mobile homes just before and after Katrina hit, spending $2.7 billion largely through no-bid contracts. It then scrambled – unsuccessfully – to sell as many as 41,000 of the homes, netting about 40 cents on each dollar spent by taxpayers.
via http://ift.tt/2wlsqvF Tyler Durden