Strong New Vehicle Sales: Headwind or Tailwind for the Aftermarket? June 2013

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1 Strong New Vehicle Sales: Headwind or Tailwind for the Aftermarket? June 2013

2 AASA Thought Leadership: Strong New Vehicle Sales: Headwind or Tailwind for the Aftermarket By Paul McCarthy and Bailey Overman New car sales are looking strong again. May new car sales came in at a 15.3 million unit SAAR (seasonally adjusted annual rate), according to Autodata. In all the 2013 forecasts from the industry or Wall Street, sales are above 15 million units. Looking forward, new sales are expected to continue to be above that benchmark and grow further for several years to come. AASA is asked frequently whether stronger new vehicle sales are good for the aftermarket or bad for my business. The answer is: yes. Joking aside, increasing new car sales bring both positive and negative drivers for the aftermarket. But overall, our analysis indicates increased new vehicle sales may actually be an indicator of positive prospects for the aftermarket. We ll explain the reasons for this counterintuitive piece of good news in the remainder of this Industry Analysis Insights.

3 Long Run tailwind: New car sales replenish and grow fleet of vehicles to repair In the long term, new vehicle sales are clearly positive for the aftermarket; we need to have more new vehicles sold so that those vehicles eventually end up serviced in the aftermarket. In other words, over the long-term, more new car sales mean a larger addressable market for the aftermarket. This is particularly important now as the aftermarket needs to refill the sweet spot vehicle population. Newer vehicles are needed in order to refill the population of vehicles in the aftermarket sweet spot, which will decline in future years as the sales trough of the Great Recession rolls through. See the below which draws upon vehicle parc data from Experian.

4 See the recent AASA special report, Sweet spot analysis, Shifting Sweet Spot Presents Aftermarket Challenge, which you can link to here, click here for more details on the impact of this temporary sweet spot pothole. The good news is that increasing new vehicle sales will help the U.S. vehicle parc return to a growth trajectory, as depicted in this chart below from Polk showing a five-year forecast of U.S. light vehicle parc. Inflow from new sales is expected to exceed the outflow from scrappage, which over time will increase the total addressable market for the aftermarket.

5 Near-term: Headwind when taken in isolation Despite this perfuming of the pig by taking the long-view, there are good reasons that aftermarket executives have been concerned about increasing new vehicle sales. Over the near-term, when taken in isolation, increasing new car sales are a threat to the aftermarket. Note we say in isolation there is a silver lining here we ll get to in a moment but we ll first explain the reasons new car sales may act as a headwind. As one example, more new vehicles will likely result in an end to ever-increasing average vehicles ages and ownership lengths that helped the aftermarket perform so strongly early this decade. While the turnover of the vehicle fleet presents some opportunities for the aftermarket (reconditioning, collision, and accessories), increasing new car sales will also mean a decline in the share of vehicles out of warranty (which reached an all-time peak in 2011 and has since declined). In addition, some of the higher net worth individuals who held onto older vehicles during the Great Recession will migrate back to younger vehicles, potentially pressuring purchasing power and ticket size in the aftermarket s segment of the market. For less affluent consumers, there is the possibility of a tipping point developing. Repairs have become expensive on today s complex vehicles. Failures on very old vehicles could push consumers into the market for new or younger cars if the repair could cost more than the car is worth. In the short term, consumers may also postpone investment in maintenance or repairs given that a purchase of a new or younger vehicle may be in their future. As aptly stated by Advance Auto Parts CEO Darren R. Jackson n a recent earnings call, the increase in the number of people purchasing or contemplating the purchase of a new vehicle will cause short-term volatility in the industry as customers are more concerned about what they invest in maintaining their aging vehicle. In sum, stronger new car sales are likely part of the answer to recent questions about why we ve seen a softening in the aftermarket from the strongly above trend sales we enjoyed in

6 The good news: A rising tide can float the aftermarket boat That said, despite these headwinds, increased new vehicle sales could actually be a positive for the aftermarket. We noted that increased new sales are a threat in isolation, but the fact is these increased new vehicle sales don t happen in isolation. The same things that drive increased new vehicle sales can also be positive for the aftermarket. AASA conducted an analysis of how aftermarket sales have performed in the past in times of increasing new vehicle sales versus declining or flat new vehicle sales. We looked at the last three significant instances of declines in new vehicle sales, stemming from the recessions in the early 1970s, early 1980s and early 1990s. A pattern contrary to the conventional wisdom appeared, as you see in the chart and table below. Expenditures on maintenance and repair actually increased slightly faster in times when new vehicle sales increased than when new vehicle sales were down!

7 Investors have recently liked to talk about the aftermarket as countercyclical. The underlying issue here is that this description is wrong the better descriptor is that the aftermarket is weakly cyclical. We do feel economic downturns, we just feel them less than most other motor vehicle and retail sectors. In turn, our weakly cyclical industry also gets to enjoy some of the benefits of an upturning economic cycle. As noted above, it is worth stepping back and considering the underlying drivers that lead to improved new vehicle sales: stronger economic growth, increased employment, higher disposable income. These are also positive for the aftermarket. A more positive economy and disposable income can make consumers more willing to maintain their vehicles as they should, reducing unperformed maintenance, which hit an all-time high of $67 billion in Unperformed maintenance (see graphic below) tends to be cyclical, hitting a peak early in recoveries as consumers are cautious about spending and reducing by billions of dollars as the economic prospects look more positive. Increased employment and income also tend to lead to higher miles driven, helping the aftermarket.

8 This storyline helps support the continued market growth forecast in the recently released Aftermarket Joint Channel Forecast, created by IHS for AASA and AAIA and depicted below. For further analysis of this forecast and for slides on the topic that AASA has created to assist members with management presentations, please click here for a members-only report. Final takeaway In sum, if history is a guide, the good economic news that brings increased new vehicle sales may offset the industry-specific headwinds it also brings. While there is reason to keep an eye on the developing impact, as this analysis has shown, increased new vehicle sales may actually turn out to be a reason to be positive about the prospects for the aftermarket in the next few years. For any questions or comments please contact Paul McCarthy at pmccarthy@aasa.mema.org or or Bailey Overman at boverman@aasa.mema.org or