My kingdom for a used car

Something very strange is happening in the used car market. Dealers from across the world — from as far afield as the UK to the US and Germany — are suddenly finding it exceedingly difficult to source inventory.

Reports of fast appreciating prices at auction have been popping up sporadically for a couple of weeks now. But in the last few days observations about the supply crunch have become even more numerous. Auto Trader, the UK’s largest second-hand car dealing platform, even launched a webinar on May 19 entitled “sourcing stock in a shortage”.

So what’s going on? Is the used car bidding war an indicator of inflationary times to come or something more transient as the market adjusts to a post-pandemic environment?

Also worth asking: how much of a black swan moment are appreciating prices in the used car market likely to be for the auto financing industry? The context of course is that personal contract purchase agreements (car loans known as PCPs) and leases have pre-determined buyback values baked into their contracts, all of them based on assumptions that used cars only depreciate over time.

In the first instance, the temptation is clearly to blame the semiconductor shortage. Auto manufacturers have been among the hardest hit by the supply crunch due to the sheer scale of electronic systems in modern car designs. Ford noted in April, for example, that the shortage would see it make 1.1m fewer vehicles in 2021, down some 50 per cent in the second quarter and 10 per cent in the second half of the year.

If new cars aren’t entering the supply pipeline at the usual rate, it makes sense that motorists might hold on to old stock for longer as a six month wait time to part-exchange an old car for new one isn’t that appetising. So fewer part-exchanges, less supply for the used car market.

But perhaps there’s more to it than just that?

Morgan Stanley’s Adam Jonas, the closest thing the world has to a celebrity auto analyst, notes the situation on the ground in the US is a bit more polarised. In a research report out Wednesday Jonas said that, on one hand, he had heard from a north-east-based Ford dealer that it was suffering from a huge lack of inventory and considering lay offs as it just didn’t have any cars to sell. On the other hand, a Toyota dealer told Jonas that it had the biggest gross weekend ever.

Jonas concluded:

Perhaps we are hearing from dealers that represent the OEMs that may be on the polar opposite side of the chipset supply chain problem. Although the above examples are anecdotal, they reflect our thesis. Based on 1Q results from suppliers and OEMs, Ford seems to stand out as the outlier with the most impacted production schedules due to chips, while Toyota actually increased production forecasts.

One reason for the difference, Jonas said, might be because Japanese automakers have more experience dealing with supply-chain disruptions. Nonetheless, he still expects a potential “sticker shock” moment that could impact the US industry over the next few months. The expectation very much, he says, is that savvy customers will buy out their leases.

As it stands he doesn’t expect a full return to “normal” levels of inventory in dealer lots until deep into 2022.

While all of this indicates that used cars might prove a better store of value than bitcoin in the short term, there are a couple of other variables that need to be factored in.

The squeeze comes at the same time that many European jurisdictions are implementing ever tougher environmental standards on drivers. This had, until recently, been seen as a reason to dump old stock that didn’t meet the new environmental criteria. Could a major supply shortage of newer cleaner cars hamper the green transition by making it even more expensive to upgrade the system?

One other under-appreciated factor is the influence of reduced rental fleet in the market, also known as the de-fleeting effect. Rental companies as a rule are fairly savvy with respect to how much idle car stock they keep on their books at any given moment. Since the market is fairly seasonal, that ensures regular de-fleeting and re-fleeting over the course of any year. The pandemic has of course messed with those seasonal trends meaning the usual replenishment cycle has been disrupted. Without new stock being brought into the rental market, the consequence is also a lack of de-fleeting stock entering the used car pool.

Whatever the causes, the next few months are certainly going to be interesting. Those with a speculative impulse and a geeky knowledge of automobiles could be well set to make a bob or two if they have the risk appetite and the driveway space to go long a rare JAAAAAAAG or two.