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Car Sales Are Flying, But Are Profits About To Start Dying?

 December 05, 2012 01:12 PM

(By Rich Bieglmeier) The Auto sector graduated from our emerging to our mature bull list in this week's sector performance review. According to Reuters, car sales hit a five-year high in November stepping in the gas by rising 15% to 1.14 million vehicles.

With news like that, it's no wonder that auto sector is catching the eye of investors. Many car industry experts believe the trend will carry into 2013. However, troubling times could be ahead for automakers as incentives and a troubling rise in inventories could hit profits hard in in 2013.

This morning, the Wall Street Journal reported, "Detroit auto makers are piling up big stocks of passenger cars at dealers despite brisk new-vehicle sales in the U.S.—a problem that executives vowed to avoid since their painful downturn three years ago." The more things change, the more they stay the same.

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We can see evidence of this by comparing the auto manufacturers account receivables (ARs) growth against sales growth. General Motors Company's (GM) ARs are up 30.6% from December 31, 2011 through September 30, 2012. Meanwhile, sales are flat during the same timeframe. At Ford Motor Co. (F), None-finance ARs increased 23.4% and sales a down in the first nine months of 2012 versus 2011. Things that make you go Hmmm.

According to Zerohedge.com, GM's November month-ending dealer inventory stands at 788,000, up 6.6% from October and 26.3% higher than November 2011. Odds are the inventory will decline somewhat as holiday sales take cars off the lots, but not enough to reverse the alarming trend.

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From iStock's understanding – and here is a free car buying tip – the way car sales work between dealers and the manufacture goes a little something like this.  GM, Ford, and the other ship the cars to your local dealer for a minimal cost. The dealer has 90-days to sell the car before they have to start paying the manufacturer.

Dealers are desperate to unload cars and trucks that are closing in on the 90-day, stale date. Here is the car buying tip – ask the car salesperson to show you the 90-day vehicles. The salesman/woman will LOVE you. They get fat bonuses for moving the old, but still brand new inventory, and you'll get a price that's near our below dealer price.

But that's the problem. The more unsold cars and trucks that fill-up dealership lots, the more aggressive pricing and incentives will necessarily become; which means lower profit margins in a business with an average operating margin of 6%.

Rising inventories and accounts receivables with declining to flat revenue will be offset by lower prices i.e. incentives and low-to-zero finance rates to move out the old to bring in the new. It's a lethal mix for profits.

The WSJ summed it up this way, "Today, all three [Ford, GM and Chrysler] face tough decisions on cutting production or profitability as inventories have soared." iStock thinks it is likely to be both. Investors and taxpayers, beware!

Perhaps, the legacy auto makers/dealers could adopt some of how Tesla Motors, Inc. (TSLA) sells cars. Showrooms with only one model for each car and then sell directly to consumers online. Eventually, an auto-major will pilot project selling cars and trucks in this fashion to catch up with the times. It's not like consumers aren't used to the practice, they do it all the time for clothes and electronics – go to a brick and mortar to try ‘em on and check'em out, then buy online. 



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