Avoid Potholes in the Auto Sector

As I mentioned in Sunday's The Week Ahead, and as you have no doubt heard by now, December auto sales were strong, coming in at a seasonally adjusted rate of 16.92 million units vs. 15.52 million a year ago. No doubt the combination of replacing older vehicles (a little over six months ago ISH Automotive put the average age of the domestic auto fleet of 252.7 million light vehicles at 11.4 years entering 2014) with the drop in gas prices has been good for the auto sector. That benefits original equipment manufacturers like General Motors (GM), Ford (F) and others, as well as key suppliers, including TRW Automotive (TRW), American Axle & Manufacturing (AXL). Given the rise in auto and truck production, suppliers have generated above-index returns over the last year, while GM and Ford shares have substantially underperformed over the same period. Initial forecasts for 2015 auto and truck shipments appear to be bullish. Last night Alcoa (AA) suggested it would benefit from strong auto-related demand in the current quarter. For 2015, the aluminum company sees the North American auto market growing by 1% to 3%, and for context that compares to GM CEO Mary Bara's estimate of 3% growth for that market in 2015. The comment that caught my ear on the call was that while inventories are down, incentives are high. Case in point, GM is slashing prices for select Cadillac CTS packages by as much as $3,000 in an effort to boost sales. In case you've missed it, Cadillac has been struggling, and the CTS sedan saw a nearly 18% drop in sales in December. Over the last few months there's been noise developing over the rise in subprime auto loans. Over the last few years, there's no question the auto industry has benefitted from a rebound in auto loans but in the second half of 2014 there was a rising snarl over the impact of subprime loans on auto demand. Most everyone recalls the word subprime and pretty much shudders, but data from the New York Federal Reserve shows that of the $11.7 trillion in total household debt outstanding, 8% was tied to auto loans and around 20% of that was subprime auto loans. The New York Fed went on to say that the level of subprime auto loan demand has been relatively steady over the last few years. Ah, but if auto loans have been growing, then that means the absolute number of subprime auto loans has also been on the rise -- hold that thought for a minute. According to data from Moody's Analytics, more than 2.6% of car-loan borrowers who took out loans in the first quarter of last year missed at least one monthly payment by November. While that may not sound like much, it was the highest level of early loan trouble since 2008, when such delinquencies rose above 3%. If you guessed that loan performance associated with subprime auto loans is also deteriorating, well you would be correct. According to Equifax, more than 8.4% of borrowers with weak credit scores who took out loans in the year-ago quarter missed payments by November. This is worrisome, as it could very well be the difference between a North American auto industry that is up 1% in 2015 vs. one that is up 3%, which would have an impact on suppliers, and the fallout among auto loan companies is a pitfall to be mindful of. Who are these players? According to Experian, the auto loan market-share leaders for new cars are Ally Financial (ALLY), JPMorgan Chase (JPM), Capital One (COF) and Wells Fargo (WFC). In the used car market, the players are pretty much the same, although the rankings are staggered somewhat differently. Of those players, the one with the least-diversified business and greatest share is Ally. Though its shares are down, it's not a stock I'd be jumping into until we get commentary on auto loan trends from competitors and data from Equifax and Experian.

Avoid Potholes in the Auto Sector

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