Herein begins a discussion concerning the all-important-metric for auto execs and analysts alike: the Seasonally Adjusted Annual Rate (of auto sales), or SAARs, for short. Why is there so much emphasis on the top-line volumes of the auto industry? As Steven Rattner describes in his exceptional account of the 2009 auto bailouts, Overhaul:
“Fixed costs are those that tend to remain constant regardless of how many units you produce: items like interest and rent payments and the salaries of permanent staff. Most businesses account for wage workers as a variable cost because companies hire and lay off workers based on production. But at GM, Ford, and Chrysler, it wasn’t that way.”
This is a pretty intuitive point – although the proportion of part-time workers has risen significantly in Detroit after the auto bailouts, the nature of the beast is such that OEM’s and suppliers’ bottom lines are still massively leveraged to production volumes.
On Thursday, after emerging from Chapter 11, Delphi Automotive PLC IPO’d by offering the public shares at $22 a piece. Now freely traded on the New York Stock Exchange under the ticker “DLPH,” the IPO was executed at the low end of the company’s projected range and at a depressed valuation of about 4.5x EBITDA – a disappointment reflected in the share prices of comparable auto suppliers and OEMs after the event. There are a lot of reasons for investors’ cold reception to Delphi’s IPO: preemptive selling by pre-petition bondholders, and the company’s 30% exposure to General Motors & Ford coupled with historically weak market share performance, to name a few. But mostly, the Delphi IPO is clearly a reflection of how people are reticent to put money into a company with cyclical exposure in a shaky market environment.
What’s particularly interesting is the level of cynicism with which market participants are regarding rather bullish signs in the domestic SAARs numbers. For example, just a few short days before Delphi’s IPO, GM forecasted a SAAR of 14mn, well above the replacement level of 12mn and a world away from financial crisis lows. This is interesting because it’s clearly a shift in focus from a domestic to a more global perspective – a totally valid move:
In fact as the chart above shows, even in just the last five years North America’s car production has held less and less influence over global production.
And it also seems, for one reason or another, the North American market is clearly saturated. As the CEO of a publicly traded auto-supplier so eloquently told me, “There will be 104–105mn vehicles produced globally next year, so who cares if the SAAR here is 13mn or 13.5mn?” Even in Delphi’s S-1, the armies of investment bankers selling the story stress the importance of a global auto market, especially China:
“According to J.D. Power & Associates, global vehicle production is forecast to grow at a CAGR of 6.5% from 2010 to 2015. In the near term, the mature markets, including North America and Western Europe, are expected to grow at 3.3% from 2010 to 2015 for an increase of approximately 6.8 million units, while the emerging markets are forecast to grow at 9.6% during the same period, for an increase of approximately 20.7 million units. We expect that nearly half of our total future growth will be generated from emerging markets, especially China, which now represents a larger market for automotive components than either the United States or Japan.”
While the levels of growth are probably overoptimistic, the point is still valid the global reach of auto companies is more important than ever and probably will continue that way going forward. In any case, with the current level of cynicism in the market, the contrarian value investor siren must be activated — more on that next time…