When Do You Sell a Cyclical?
Board: Ford Motor Company
[Disclosure: The Post of the Day Editor owns Ford]
Rob, you wrote: Naturally, a recession in Europe (partially underway already) is going to be a drag on the US.
Is it? Will it drag on the total economy as measured by a proxy like the stock market, or on the real economy? I think that’s the distinction in my mind. Yes, European defaults will be an issue for companies with European operations. Yes, it will be an issue for financials. But, will it impact US consumers as severely as some think? Will it derail our recovery, or blunt our recovery? More to the point, will it impact Ford’s sales in the US? North America still drives the market, especially for Ford. Asian margins are too thin. European margins are thin, even when things are okay. South American margins are good, but volumes are low. North America drives profits, and North American pent-up demand is large. It’s potentially very large…
The question here is when to get off right? When do you sell a cyclical? Ford is actually one of the stocks that made Magellan. In fact, Lynch cites it as the single most important contributor to Magellan’s success. In “Beating the Street” he sketches out his logic for buying Chrysler and Ford during the recession in the early 1980s. A principal factor was pent-up demand:
When I took a big position in the Autos in the early 1980s, annual car and truck sales in the US had declined from 15.4 million to vehicles in 1977 to 10.5 million in 1982. It was possible, of course, that they would fall further, but I knew they wouldn’t go to zero. A… reliable indicator is “units of pent-up demand.” I located this telling statistic in a chart that’s published in a Chrysler corporation publication…
In the four years from 1980 to 1983, when the economy was sluggish and people were trying to save money, actual car sales lagged the trend by 7 million vehicles—seven million people who should have bought cars and trucks had delayed their purchases… Sure enough, we had a boom from 1984 to 1989, years in which auto and truck sales exceeded the trend by a combined 7.8 million units.
After four or five years when sales are under the trend, it takes four or five years of sales above trend before the car market can catch up to itself. If you didn’t know this, you might sell your auto stocks too soon. For instance, after the boom year of 1983, when auto sales increased from 10.5 to 12.3 million vehicles, you might have decided to take your profits in Ford and Chrysler stocks because the auto boom was over. But, if you followed the trend, you could see that there was still a pent-up demand for more than 7 million vehicles that wasn’t exhausted until 1988.
I think that US demand can overcome European softness. NA drives the market, and when it comes right down to it, we are still in the midst of the largest per capita US sales drop in the history of the industry. Pent-up demand is huge. In mid-2011, 50MM vehicles on the road in the US were over 10 years old (source, Ford Dec. sales call). Sales are just beginning to recover. Yet, people still seem to think that upside in NA is limited and that we’ll never see sales rates near the early-2000s highs, when SAAR ran in the 17MM range. Frankly, I think a failure to reach those levels is unlikely.
For reference, here’s a chart I made of US SAAR from 1967 to the present; data courtesy of the Bureau of Economic Activity:
We’re in a deep slump right now, to be sure. It’s popular (especially in the media) to cite our overconsumption as a cause of these problems. In that vein, one might consider the US SAAR of 17MM as an outlier. We ran too high, now we’re paying the price. But, cycles are a normal part of the process. On a population adjusted basis, that 17MM is not an outlier at all. The population of the US was 226,545,805 in the 1980 census. It was 308,745,538 in the 2010 census, an increase of 36%. There were 15.4MM vehicles sold in 1977. 15.4MM x 1.36 = 20.9MM units. Does 17MM still sound outlandish? Does it sound out of control? Does is still sound like overconsumption?
Using US census data, it’s possible to normalize SAAR to population. If you do that, you find that on a per capita basis, 2001- 2005 sales rates are actually quite average. If you follow the next link below, you’ll find a graph detailing the data. The y-axis corresponds to total yearly sales/person, graphed by year from 1967 to the present on the x-axis.
The sales rate at most times runs in a channel between 0.05 to 0.06 sales per year per person. That means that between 5 and 6 of every 100 people in the US buys a car each year. Those 2001-2005 high sales rates actually fall below the peaks seen in segments of the 1970s and 1980s. In addition, the lows seen in recent years are far below any seen in the last half century on a per capita basis. Note how deep the 2008 drop is and how long it’s been sustained. The previous lows of 0.04 sales per person (4 per 100 people) seen in 1974/1975 and 1981/1982, were broken in August of 2008 and not reached on the way back up until October of 2010. We fell 25% from those levels. Note that 1981-1982 is the recession that Lynch is referencing. We’re well below those levels. Way below those levels in fact, on a population adjusted basis. Remember, we’re not back to normal sales levels yet. We’re just back to all-time lows on a population corrected basis. We still have not reached normal sales levels.
But, let’s look at it another way; a simpler way. Let’s accept that 17MM was an aberration and is not attainable. Let’s say 15MM is the “new normal” sales rate. Personally, I’m not a believer in the “new normal” cliché. But, let’s use it as a starting premise. From 2008 to the present, we’ve accumulated approximately 12MM units of pent-up demand, based on an assumed 15MM normal trend rate:
[See post for table.]
Now, this is admittedly crude. All I’ve done is average the yearly numbers from the BEA data. But, I think you get the point. That’s about a year’s total sales missing, and we’re not back to trend yet, nor are we projected to get back to trend this year. That’s a lot of cars. Framed once again on the 1980s recession, their drop of 7MM was only half of the then-current run rate of 15MM. We’ve got approximately 12MM pent-up and we’re not done accumulating missing sales yet. It’s rapidly adding up to a full year of missing sales. So, I don’t think it’s at all unlikely that we could see a push back through 15MM to 17MM. And since NA drives profitability, I think the Autos aren’t a sell right now. Are they a buy? It depends on your other prospects. I think they’re relatively safe in terms of downside, especially if you average down on a dip. And Ford’s momentum in terms of refreshening put it in a good position strategically to boot.
You though, have other concerns, now that you’ve retired. If you’re looking to diversify that may change the equation. But, I personally don’t think Ford has run its course. We’re just in a market rut, not the top of the cycle. Could there be another leg down? Yes. But, it would just mean more pent-up demand and even greater upside on the other side of the drop. I’m holding my position, which amounts to 7% of my total port. Short term I could be wrong, but long term, I suspect I’ll be right.
Just my inexpert opinion,