Harvey Smooths Speed Bump for Used Vehicles

The Takeaway:

Hurricane Harvey is estimated to have damaged 300,000 (Cox Automotive) to  1 million (Black Book) vehicles. Cox Automotive Chief Economist Jonathan Smoke expects that tighter vehicle supply and increased demand will lift used vehicle prices for two to three months. He expects adjusted used vehicle prices to remain “strong” for the remainder of 2017. JDP and BB indices have been relatively flat since February and Manheim’s Index has increased, which may indicate that used vehicle prices may be more stable in 2H17 versus our expectations. Now it is likely that used car prices will be flat for the next several months due to the vehicle damage caused by Hurricane Harvey. If Hurricane Irma makes landfall in Florida or the eastern seaboard, more vehicles are likely to be damaged and that will add further price support to used vehicle pricing in the coming months, which could result in the JDP and BB indices being up for 2017. Improving used vehicle prices would benefit Ally Financial (ALLY), Credit Acceptance Corp (CACC), Santander Consumer (SC), and Capital One Financial (COF). For more information on used car pricing trends, please see our August 17, July 18, June 16, June 1, May 26, and May 17 reports.

  • Hurricanes may improve depreciation outlooks. In their 2Q17 earnings calls, Ally Financial (ALLY) maintained its depreciation guidance at 7% for 2017 and General Motors (GM) expected more declines in vehicle values in 2H17. The vehicle damage from Hurricane Harvey and possibly from Hurricane Irma could result in these expectations improving as demand for used and new vehicles is expected to increase over the next several months.
  • Estimated damaged vehicles center around 500,000 units. Cox Automotive estimates are 300,000 to 500,000 units and Black Book’s estimates are 500,000 to 1 million vehicles damaged. We used Edmunds Used Vehicle Market Report quarterly used car sales data and the St. Louis Federal Reserve Bank’s new car sales data, not seasonally adjusted, and estimated that used vehicles represent 69% of total vehicle sales on average from 1Q12 to 1Q17 (Figure 1). Applying 69% to 500,000 vehicles that will potentially be replaced indicates an increase in used vehicle demand of 346,000 units. These additional units represent an average increase in quarterly used car sales of 3.7%. These additional sales will occur primarily in the third and fourth quarters of 2017. If damaged vehicles are at the high end of 1 million units, then we estimate used vehicle demand will represent an increase of 7.4% of quarterly used car sales. Any impact from Hurricane Irma will only raise the demand for used vehicles. Hurricane Harvey on its own may have wreaked enough havoc to cause used vehicle price indices to be flat and possibly up in 2017 versus our pre-hurricane estimate of down at least 7%.
  • Used vehicle demand to support used price indices. The Cox Automotive estimate of strong price support in 2H17 is based on Manheim used vehicle data. The Manheim index was up 4.3% for the first seven months of July, compared to the J.D. Power Valuation Services (JDP) and Black Book indices, which were down by 3.8% and 1.6%, respectively. Using Black Book’s weekly Market Insights, we estimate the annualized YTD price change for cars to be 14.5% and 11.7% for trucks; however, YoY, cars have depreciated 19.3% and trucks by 16.0% (Fig. 7). Prior to Hurricane Harvey’s devastation, we were expecting used vehicle prices to decline by 7% or more. Now prices could be flat, and Hurricane Irma could result in the indices being up for 2017.
  • Off-lease vehicle volumes set to hit multi-year highs. JDP reported that late-model vehicle auction volume was 1.68 million units YTD July 2017, up 7.2% from 1.57 units YTD July 2016. Off-lease vehicle volumes will be a record 3.6 million units in 2017 and the number is  expected to continue to increase until it peaks at 4.6 million units in 2020. We expect off-lease volumes to result in above-average annual depreciation in 2017 and 2018. AlixPartners  called this trend a “used-car time bomb.”
  • New car sales timeline is increasing. JDP highlighted that WardsAuto reported that the days’ supply of light vehicles was 69 in July, down 5 days from June, but up 8 days from July 2016. In April, the American International Automobile Dealers Association reported the “average length of time a car sat on a dealer’s lot hit 70 days in March – the longest stretch of time since July 2009.” The increased inventory levels do not appear to have abated, which will likely keep incentives high.
  • New vehicle incentives are elevated. JDP reported that incentives increased by 6.7% in July, marking 28th consecutive monthly increase. Incentives represented 9.9% of a new vehicle’s MSRP, up from 9.6% in July 2016,  according to Automotive News. This is the highest level since 2009 when incentives hit 11.4% and is the 11th time in the past 12 months that incentives exceeded 10%. Incentives are likely to remain high to move inventories that are building on dealers’ lots.
  • Conclusion. Hurricanes Harvey and Irma may provide some temporary relief from declining used car prices; however, the trends of increasing off-lease volumes, constrained auction capacity, tighter underwriting standards, higher new car incentives, and an elongated new car sales timeline are not likely to abate, which should result in continued used vehicle pricing pressure once the hurricane-related demand abates towards the end of 2017.


COMPANIES MENTIONED IN THIS REPORT
Santander Consumer (SC)
Capital One Financial (COF)
Credit Acceptance Corp (CACC)
Wells Fargo (WFC)
Ally Financial (ALLY)
Consumer Portfolio Services, Inc. (CPSS)
TCF Financial (TCF)
Fifth Third Bancorp (FITB)
Regions Financial (RF)
Citizens Financial Group (CFG)

RISKS
The legislative and regulatory agendas are subject to change at the discretion of leadership. Unprecedented economic conditions could instigate unanticipated and/or sweeping shifts in policy. Predicting the future is a hazardous endeavor and economic / market forecasting is an imprecise science. Actual outcomes may differ substantially from our forecasts. The predictions and opinions expressed herein are subject to change at any time.

ANALYST CERTIFICATION
I, Edwin Groshans, certify with respect to each security or issuer covered in this research report that (i) the views expressed in this research report accurately reflect my personal views about those subject securities or issuers and (ii) no part of my compensation was, is, or will be, directly or indirectly, related to the specific recommendations or views expressed by me in this research report.

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IMPORTANT DISCLOSURES
The research analyst has received compensation based upon various factors, including but not limited to Height Securities’ overall revenues, which includes investment banking revenues.

Disclosures for SC: None
Disclosures for COF: None
Disclosures for CACC: None
Disclosures for ALLY: None
Disclosures for FITB: None
Disclosures for WFC: None
Disclosures for CPSS: None
Disclosures for TCF: None
Disclosures for RF: None
Disclosures for CFG: None

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