CreditSights: Autos Crimp Corporates' Performance
The fifth month of the year is now behind us and for all that is new and attention-grabbing in the financial world, much is turning out exactly as expected. The lackluster performance of the corporate sector falls into the latter category. On a year-to-date basis, corporates are lagging the Treasury market's returns.
That the sector is not delivering a strong level of outperformance is not much of a surprise. The significant spread tightening seen in 2003 always looked like a precursor for diminished returns this year and has proven to be simply a case of not much being left on the table. It is notable however, given that we are seeing evidence of a robust level of economic growth and a general enhancement in credit quality as the cycle matures. Despite this, the high-beta compression trade has turned and sectors with wide spreads are offering no guarantee of outperformance. This is seen as one looks into the speculative-grade arena as high-yield bonds have underperformed substantially.
One of the leading culprits of the poor performance in the investment-grade arena is the auto sector. Rising inventory levels, fluctuating sales volumes, increasing materials costs, significant refinancing needs and perceived sensitivity to the two major trends of 2004 (rising interest rates and rising oil prices) have all played their part in injecting volatility into the sector. Whether the auto sector's fortunes will change is now more a tale of the developments in these fundamental trends than it is an assessment of the value of the additional spread that is on offer on the sector.
On that score, May's vehicle sales numbers were more negative than we hoped for. May U.S. light vehicle sales increased 7.6% from the 2003 period, totaling 1.63 million units, about 6% higher than we had expected heading into the final weekend of the month (change is on a daily sales rate basis--26 days versus 27 last year). On a seasonally adjusted annual-rate basis, light vehicle sales totaled 17.8 million units compared with 16.3 million units last year and 16.4 million units in April. We had expected a SAAR of around 16.9 million units; essentially all of the upside from our estimate is accounted for by the stronger than expected sales of the Japanese-based manufacturers. In fact, sales from Honda, Nissan and Toyota were about 50,000 units higher than we had expected; each gained share versus last year and each of the Big Three lost share.
The industry, and General Motors in particular, had become increasingly bullish on May's performance over the past week or so. Unfortunately for the Big Three, most of the kudos goes out to the imports. The April-June period, in our opinion, is crucial for the industry owing to record levels of dealer inventories at the Big Three. The Big Three also announced initial schedules for the third quarter of 2004; production for the Big Three is targeted to be down 2.3% to 2.55 million units. To reach our target for calendar year 2004, light vehicle sales of 16.75 million units (which is consistent with most in the industry), the monthly SAAR will need to average about 17 million the rest of the way.
Some of the more important issues facing the industry and the Big Three include: the level of sales and market penetration; incentive spending and increasing dealer inventories. May sales were the strongest thus far in 2004, pushing the year-to-date total up 3.2% and putting the industry on track to reach 16.75 million light vehicles for the year. Through the first five months of the year, GM's market share is flat, DaimlerChrysler has lost about one-half of a point and Ford Motor has been hammered, losing 1.2 points in penetration. On a combined basis, the Big Three captured 61.2% of the U.S. light vehicle market in May, down 2.0 points from last year. Big Three U.S. dealer inventory levels reached 3.0 million vehicles for the first time at the end of April, above every monthly total as far back as 1985. The initial data for May shows dealer stock levels coming down by about 100,000 units but inventories remain at the highest level since 1989.
Inventories typically come down by about 15% between April and September, but we believe the group needs to shed closer to 25%. GM and Ford released updated schedules for the second quarter and there was very little change, and each offered their initial schedules for the third quarter. If industry sales don't maintain a pace at or near the 17 million mark, we believe schedules will need to be reduced further.
