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Putting the Brakes on the Automotive Industry

By: Darren Sun


Overview

While the media tends to focus on the performance of the mortgage industry as an economic indicator, the automotive industry can be just as telling of consumer behaviours. While a home purchase tends to appreciate over time, a car will do quite the opposite. Being a depreciating asset, the value declines once the wheels leave the dealership, bar a select few luxury vehicles. In times of low consumer confidence, luxury items such as vehicles are the first to experience declines in sales. New car sales have declined for the 16th consecutive month, with national figures from the Federal Chamber of Automotive Industries (FCAI) showing a 2.8% drop in July year on year. This is a softening from the 9.6% decrease year on year in the month of June, however it is partially offset by July having an extra selling day compared to last year.

Credit Markets

Credit tightening has been a key factor in the reduced car sales figures. Following the royal commission, just as in the mortgage industry, lenders are reducing their buying appetite. With the implementation of the Banking Code of Practice (BCOP) and the Hayne investigation, decline rates have increased by 10% with more thorough income and expense verification. With ASIC losing their landmark responsible lending case against Westpac, lenders will continue to use the HEM benchmark for expenses for the foreseeable future. This will help to keep decision turnaround times from rising further, having already seen a 25% increase since the Hayne commission.

This credit tightening is partly justified with 30 days car loan arrears nearing all time highs, currently sitting at 2.65% which is 77 basis points higher year on year in April. This is almost double the 30 days mortgage arrears rate currently at 1.53%, 17 basis points higher in April year on year. Stagnant income growth and rising unemployment have pushes arrears rates higher, while the decline has been softened by back to back RBA rate cuts. Secured car loans still bear double the rate of an average mortgage, due to increased risks of negative equity.

Fiscal Policy

Pressure is building on the Morrison government to abolish federal luxury car taxes, with opposition claiming it fails to target true luxury vehicles and instead impairs the average household. The luxury tax currently sits at 33% for fuel efficient vehicles over $75,526 and all other vehicles $67,525. This is in addition to the state luxury car tax of 7% for vehicles over $100,000 and 9% for vehicles $150,000 introduced by the Victorian government July 1st. This was the precedent set by the Queensland government last year when it imposed a 2% tax on vehicles over $100,000. NSW followed similar interests however didn’t eventuate due to election of the Gladys Berejklian. Many are calling this the “Landcruiser Tax” with the luxury tax generating more revenue from 48,000 Toyota purchases than Porsche, Ferrari, Maserati and BMW.

The tax was introduced in 2001 as an effort to save local Australian car manufacturing. With the closure of the industry in the third quarter of 2017, it is now a mostly redundant tax, working to effectively deter new vehicle purchases. The Toyota Landcruiser is the 5th most popular vehicle in Australia with 2,034 sold in April. The Toyota Hi-lux, Ford Ranger and Toyota Prado, all within the top 10 best selling vehicles, are also effected by the luxury car tax. The tax generated $695 million over the last financial year which was 0.17% of total taxation revenue. The LCT is facing its main abolishment risk from Australia’s proposed free trade agreement with the European Union. The tax will likely be rescinded to accommodate the request of the EU, which claims it deters purchase of their German luxury vehicles. This remains to be confirmed as the uncertainty surrounding Brexit remains a key event.

Public Markets

A.P. Eagers Limited (ASX : APE) and Automotive Group Holdings (ASX : AHG) have posted 27% and 24% returns respectively over the past year, performing well despite a weakening market. AP Eagers and AHG are both dominant in the new car dealership space, with a combined market share of 11.9%. The ACCC has approved a proposed merger of the two companies, with a proposed all-scrip takeover of 1:3.6 accepted by the AHG board in May. A combined entity would boast a $3.12 billion market capitalization, and own a combined 242 car dealerships in Australia and New Zealand, with an additional 68 truck and bus dealerships nationwide.

Carsales (ASX : CAR) has posted half yearly reports of an 8% increase in EBIDTA to $98 million, in line with previous earnings expectations. This was primarily driven by increased penetration into international markets, with a 1605% revenue growth in Carsales Asia year on year. Domestic revenue increased 8% due to the maintained strength of the used car market which avoids some of the credit and tax risks mentioned earlier with lower purchase prices. Carsales is currently trading at a 1 year forward P/E multiple of 23, roughly in line with historical averages. Gearing ratio remains high at 2.14x, however is inflated following their 50.1% acquisition in SK Encar as part of their Asian entry.

Smartgroup Corporation Ltd (ASX : SIQ) provides salary packaging and novated lease services to government, health and corporate sectors. It provides valuable tax savings through pre-tax payslip deductions towards vehicles, mortgages and utilities. Trading at 11x EBIDTA and 15% EPS growth, the company maintains a strong balance sheet with low capital expenditure and high cashflow levels.


Disclaimer: The views expressed in this article are solely that of the author’s, and do not necessarily reflect the position of UNIT nor the University of Melbourne. Transacting off this information is done so at one’s own risk, and individuals are encouraged to consult a finance professional before making investment decisions based off of this article.

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