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My car seems to be beating the stock market. It’s nothing special—a midsize, mass-market sport-utility vehicle leased in September 2020. On the pandemic supply-chain timeline, that’s after the toilet paper panic and just before the everything-else shortage. And yes: leased. I get a new car every three years to avoid the hassle of repairs and periodically clear my seat rails of Happy Meal fries.
The lease is based on a $40,000 purchase price and a $26,000 “residual” value at turn-in, which I can pay for the car if I want. I’m running so far over my mileage allotment that I’m starting to suspect myself of sleep-Uber-driving. That should subtract from the car’s actual value at turn-in, yet I see identical, high-mileage cars selling now for $33,500. If those prices hold for a few more months, I’ll be “up” on my buy option by 29%. That’s two points more than the
S&P 500
index has returned over the same stretch.
I’m no vehicular Warren Buffett. In fact, I’m underperforming the benchmark. The Manheim Used Vehicle Value index is up 35% since September 2020. It started to fall late last year, but this year it’s rising again. The causes have shifted slightly.
Initially, car production plunged amid a chip shortage, and buyers turned to used vehicles for lack of other options. Now bottlenecks are easing and inventories are rising, but car makers remain cautious. The industry has gotten used to plump profit margins, and with financing rates sharply higher, the outlook for demand is unclear.
Meanwhile, leasing has fallen out of favor—finance companies don’t want to get caught overestimating residual values if used-car prices crash. And many drivers with existing leases face favorable math like mine, so they buy their cars rather than turn them in. That has crimped a key source of supply for used-car lots and sent dealers bidding up prices at auctions. Increasingly, they’re competing with the rental companies, which typically buy new, but manufacturers have shut down low-margin production.
Put it all together, and buyers are in a difficult spot. Prices for new models are up 21% since September 2020, according to government inflation data. That tracks with my car: A new one with similar features now lists for $48,000. Until recently, that price would have felt like a minor splurge. Last month, it was more or less the average new-vehicle transaction price, according to Edmunds.
In a report this past week, Edmunds called sub-$20,000 vehicles “nearly extinct,” and ones under $25,000 “next in line.” Just 17% of new vehicles sold last month were under $30,000, versus 44% five years ago.
If price relief is on the way, it isn’t hurrying. U.S. new-vehicle inventory hit 1.83 million units last month, up some 73% from a year ago. But prepandemic inventory was over roughly 3.5 million units. “We’re probably into 2024 before inventory levels fully recover,” says Stephens auto analyst Daniel Imbro.
Used-car chains that cashed in during the pandemic are looking humbler now. When
CarMax
(ticker: KMX) reports results for its fiscal fourth quarter on Tuesday, Wall Street expects it to show an 11.9% decline in same-store sales—better than last quarter’s 22.4% drop, but not good. The stock is down 34% in a year. It goes for 23 times projected earnings for the four quarters ahead, or 18 times the four quarters after that, once conditions have presumably turned more normal.
Imbro at Stephens is not bullish on used-car chains in general. Prices could moderate in the back half of this year, but “it’s not going to be a precipitous fall,” he says. Used-car loan rates recently averaged 10.3% for all buyers and 7.8% for ones with prime credit, according to Experian. Challenged affordability will continue to cut into sales volumes.
Things look better for new-car dealers. Limited inventories have held down the cost of stocking showrooms, and with little need for discounting, profits per vehicle are up. Those stocks have done decidedly better of late, but still trade at low price/earnings ratios. There is a “contentious” debate over whether new-car dealers are overearning, says Imbro. He likes ones with a high mix of luxury vehicles, limited exposure to manufacturers that might ramp up production too quickly, and sales footprints in economically vibrant areas. The list includes
Group 1 Automotive
(
GPI
), at 5.6 times forward earnings estimates;
Asbury Automotive Group
(ABG), 6.3 times; and
Penske Automotive
(PAG), 8.6 times.
As drivers hold on to their cars for longer, parts and service chains can continue to thrive, too. Their good fortune is reflected in their share prices.
O’Reilly Automotive
(ORLY) trades at 22.7 times forward earnings, and
AutoZone
(AZO) at 18.2 times.
Speaking of which, if anyone knows a good tip for seat-rail fry removal, I might be in the market soon. Still deciding. I’m not wowed by any of the features on new models, but the effective $7,500 discount between my lease buyout price and the used-car market might be too tempting to pass up.
On the other hand, before the recent run-up in car prices, there was a 14-year stretch where prices rose only 3% in total. And that $48,000 new model is almost reasonable in Rabbit-adjusted terms: Following two 1970s oil price shocks, my family traded in our Ford Country Squire wagon for its first new car: a 1980 Volkswagen Rabbit, which would be mine a decade later. It went 50 miles on a gallon of diesel, but it was slow and soot-belching, with window rollers that seemed to break two at a time.
Original price: around $14,000. Adjusted for inflation, that’s $50,000 today. No hands-free power liftgate, panorama moonroof, lane departure warning, or temperature-controlled seats, if you can imagine such deprivations. Just a pop-up cigarette lighter. It’s amazing that I’m here to tell the tale.
Write to Jack Hough at jack.hough@barrons.com. Follow him on Twitter and subscribe to his Barron’s Streetwise podcast.
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