The car industry is one of the most important consumer businesses to the global economy.
It’s easy to see why. Other than a house, a car is likely to be the largest single purchase an individual makes. And unless you live in a city with a decent public transport system, most people find that they need a car to get around conveniently.
But the scale of the post-financial crisis recession hit the industry hard.
Drivers in Europe and the US stopped replacing their cars. Younger people put off buying their first car, or even learning to drive in some cases. There have even been features in the US press warning of ‘peak car’ – that a whole new generation of non-drivers is being created.
As usual, when you read these sorts of ‘new normal’ pieces, it generally means the ‘old normal’ is right around the corner.
So it is with the car business. A combination of cheap money and an old-fashioned cyclical recovery, means that car sales are bouncing back.
But there’s still plenty of room for you to profit – here’s how…
China was always over-hyped – but now it’s underplayed
Like nearly every other consumer business, the big driver behind the car industry before 2008 was China.
Remember those stories? “If everyone in China bought a fridge… if everyone in China buys a smartphone… if everyone in China buys a handbag…”
China’s urbanising population was the gift that would never stop giving to investors in Western consumer stocks, particularly luxury ones.
Now of course, it’s clear that the Chinese economy is slowing. And as our editor-in-chief Merryn Somerset Webb has noted, the crackdown on corruption is hitting sales of luxury cars (which are an obvious sign that civil servants and officials are receiving bribes).
And as is the way with markets, investors are starting to think that the whole China story was one big illusion.
However, looking at the cold facts, China is clearly still a market waiting to be tapped by the car industry. According to the World Bank, there are less than six cars for every 100 Chinese people. This contrasts with 52 for the UK and 80 for the US. Even Thailand, which has a similar GDP per head to China, has close to 16.
And while China has made lots of wasteful investment, all that building has left it with a pretty well developed highway network. Beijing intends to increase the national road system by another 1,254 miles. The World Economic Forum now rates the quality of China’s road network on a par with Italy’s. (That may say more about Italy’s roads than China’s, but you get the point.)
At the same time, the Chinese government is trying to generate more economic growth from consumption, rather than building stuff that no one needs. This will not be a smooth process. But with wages rising rapidly, attitudes are changing, especially among younger Chinese.
Industry surveys suggest that most Chinese citizens in their early thirties or younger now see car ownership as a necessity, says Carlos Gomes of Scotiabank. But around three quarters of them have yet to buy a car.
This suggests that in the absence of a truly epic collapse, car sales are likely to continue growing rapidly in China.
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America needs to replace its ancient cars
Meanwhile, car sales are suddenly booming in the US, growing by 17% year-on-year. Indeed, sales are now running at close to the pre-crisis peak. Another good sign is that dealers’ inventories are running low, which means demand is outstripping supply. Even the price of second-hand cars is increasing, with the used car dealers’ trade association predicting a shortage.
This is being driven by several factors. A strengthening economy and jobs growth has left more people in a position to consider purchasing a new car, of course. But a more critical factor is the sheer age of vehicles on the road now.
Following the financial crisis, people simply didn’t feel confident enough to buy new vehicles. So the average age of cars and light vans on American roads is now a record 11.4 years. Experts reckon that 12 years is about the limit for a car before it starts becoming too expensive for the average person to maintain.
So the simple need to replace old stock is going to be enough in itself to boost US sales for the next few years.
Easier availability of credit is another big factor. With interest rates still low (despite the recent squeeze), buying a car on finance looks cheap which means dealers don’t have to offer as many discounts, or other incentives, to boost sales. That in turn means more profit for the manufacturers.
One dependable car maker to buy now
One car company we like a lot is the German firm Volkswagen AG (LSE: VKW). While it does own a few luxury brands, like Porsche, most of its models are in the solid mid-range bracket.
That means it can appeal to consumers who want a reliable new car, but don’t want to spend a huge amount on something flashy. That gives VW a good chance of winning over US consumers who are now buying for the first time in several years.
Meanwhile, its joint venture with the Chinese First Automotive Works gives it exposure to the rapidly-growing market, especially the critical budget end. Indeed, it is the second-largest foreign car firm in China (behind GM). All this means that it is projected to maintain solid revenue growth of around 4-5% a year until 2016.
Most importantly, VW is cheap on 7.8 times earnings, falling to just over six times by 2015. It also trades below the value of its net assets, which makes it a lot cheaper than several of its rivals. For instance, BMW and GM trade on 1.57 times and 1.79 times book value respectively.
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