We have had a few weeks to reflect upon the recent results from many of our publicly traded aftermarket companies. Heading into the earnings season, we were confident in our estimates in spite of this being the first quarter of challenging year over year comparisons.
Out of the 15 companies that reported earnings (Pep Boys had not yet reported), 11 posted positive surprises relative to our expectations, two were in line with our estimates, and only two reported disappointing results. Overall, this was a very good performance and indicative that underlying trends remain strong.
So is this going to be another solid year for the aftermarket? Likely, in our view. There should be some noise when Q1 results are reported in late April and early May stemming from weather patterns that created multi-day disruptions across much of the country, but in general we think operating performance may once again surprise some investors.
In fact the weather patterns (severe cold) may have set up for a very strong spring/early summer. Batteries, hoses, and belts, which are critical to vehicle operation, tend to break when weather reaches extremes. Significant precipitation increases demand for wipers, chemicals, and fluids. It also damages roads (potholes, etc), leading to suspension issues (shocks and struts). Often, damage created from unfavorable weather may not show up for 2-3 months and this is where we think investors may be underestimating the potential sales benefit.
But not to appear too positive, we think there are two near-term issues that could dampen some of the enthusiasm in coming months. First, we are closely watching gasoline as prices increased $0.04 per gallon last week to a national average of $2.79 continuing a trend over the past four weeks where gasoline prices have increased $0.18. Right now, consumers are paying on average roughly $0.88 more per gallon versus this time last year.
We have found that consumers tend to adjust relatively quickly to modest changes in gas prices, however, once gasoline prices hit the psychological mark of $3.00 per gallon there is typically some change in driving and spending habits (on automotive repair and related items). Unfortunately, we don’t think the recession is far enough removed for the consumer to absorb the impact of surging gasoline prices and would be generally concerned if the national average began to climb back to the $3.50 level. Summer is just around the corner, and seasonally there is a tendency to see a rise in prices at the pump.
Second, and while we don’t anticipate this being a big deal, investor perceptions could be swayed depending on how the dealership closing debacle unfolds. We haven’t agreed with the Obama Administration’s handling of GM, and as taxpayers (maybe shareholders is the better word) the arbitration afforded to dealer franchises that had been notified of closure may prove to be a setback to recovery. GM recently announced its intent to reinstate nearly 700 dealers from the 1,110 arbitration claims it received and Chrysler Group has about 400 dealers using the arbitration process to appeal the loss of their dealerships (although Chrysler recently indicated that it did not plan to follow suit after GM’s partial reinstatement).
The domestic manufacturers believe there are simply too many domestic dealerships relative to the number of vehicles being sold, and allowing more dealerships to remain in operation will not solve this problem. The underlying issue remains that the number of new units sold is down substantially from recent years, with Q1’10 seasonaly adjusted annual rate (SAAR) likely to run in the range of 10.6 million versus 16.2 million units solid in 2007. That’s nearly 6 million fewer touch points for the dealers, and close to 10 million fewer touch points when looking at the cumulative loss from trailing five-year new unit sales, and it is having a noticeable impact on warranty repair work.
For the automotive retailers, we expect the warranty business to be under pressure until sometime in early 2013. The aftermarket should benefit in the short term but can’t afford to become too complacent. With the warranty segment under such pressure, we suspect that dealers will become even more aggressive in targeting customer pay work through attacking the general maintenance category and attempting to close the negatively perceived price gap relative to the independent aftermarket.