Moreover, speaking of inflation, you should know that there are two schools in the interpretation of the current situation. The first, that of central banks, is to think that inflation is temporary (even if the Fed had to admit in December, after a year of accelerating prices, that it was durable in view of their own definition ). The second is rather to think that the last decade was an exception and that inflation is picking up, and this, for a long time. I am not here to give my opinion on the more or less durable nature of this inflation. To tell the truth, I don’t know much about it as this parameter of the economy is unpredictable. Instead, I will focus on the used vehicle market and whether investing in used dealerships is a good hedge against this risk in 2022.
Those looking to invest in stocks of used car companies and dealerships should understand the trends that have played a major role in the growth of the industry. The “digital revolution” has been the biggest disruptor in the industry. According to consulting firm McKinsey, the shortage of semiconductors – components essential to the functioning of today’s cars – has played a major role in the acceleration of sales and prices of used cars.
Faced with the shortage of semiconductors
The current shortage of semiconductors has impacted the production of new vehicles, resulting in demand exceeding supply. This results in fewer discounts being offered across the market, causing some cars to sell for more than their original price, and demand spills over to the used car market. This is also often the case: the markets for new cars and used cars are historically closely linked. High prices in one of these markets affect the other.
The average price of a used vehicle in the United States jumped more than 21% from mid-2020 to mid-2021, from $20,900 to around $25,400. For new cars, buyers pay about $40,800, up about 4.9% from a year earlier.
Source: Edmunds
In the face of galloping inflation
Here is the evolution of consumer prices over 12 rolling months (December 2020 to December 2021):
Source: US Bureau of Labor Statistics
And here is consumer price inflation since 1960:
Source: FRED
For more than 10 years, the 2.5% threshold has not been crossed upwards. Historically, inflation of the order of 2 to 3% is not abnormal, it is even rather the norm. This does not mean that the rise in equity markets is over forever. On the contrary. Inflation held at around 2-3% is favorable for equities. The categories of shares that are doing the best are firstly stocks with pricing power, ie an ability to pass on the inflation of their production costs to their end customers; and secondly the inflation-correlated stocks of commodities and consumer goods: gold stocks, commodities, oil companies and our category of the day: used car dealerships.
As you can see in the first graph, inflation has increased by 7% over 12 months in the United States. The Core CPI, that is to say without food and energy, shows an increase of 5.5%. If you scroll down the chart a bit, you can see that used cars and trucks are up 37.3% YoY, so there has been an acceleration recently, especially in June 2021 (+10.5 %), in October (+2.5%), November (+2.5%) and December (+3.5%). Used cars are historically a good hedge against inflation.
Conclusion
According to automakers, chip shortages are likely to continue into 2022 and inflation doesn’t seem to want to calm down yet. Used car dealerships forecast significant growth prospects for 2022 and 2023 while posting reasonable valuations: capitalizations between 6 and 15 times current year earnings. The market seems to anticipate a slowdown in the sector due to an improvement in the semiconductor supply chains. We believe the backlog of new car chip production will take longer than expected to clear up. The following stocks could thus benefit from this in 2022.
The values to follow
Carmax
Asbury Automotive Group
Lithia Motors
carvana
Autonomy
Sonic Automotive
Group 1 Automotive
Advance Auto Parts
Universal Technical Institute
Penske Automotive Group
America’s Car-Mart
KAR Auction Services
CarGurus