Auto Market Profitability Could Drop In 2017 – Forbes

Posted: Friday, February 10, 2017

Ford Motor Company (NYSE: F) and other auto makers could see their profits drop in 2017 as a glut of used cars appear on the market. According to JD Power, the number of cars whose leases expired in 2016 increased by 33% compared to the number in 2015, and that figure is further expected to increase to 3.36 million in 2017. This is close to 20% of the overall vehicles sold in 2016 and implies that the average rate of depreciation of a leased vehicle’s value has grown to 23% compared to 18%.

Automakers’ financial divisions make money through lease payments. The monthly value of these payments is a function of the difference between the price of the vehicle at the time of sale and the expected value of the vehicle at the time of lease expiry. If the value of the vehicle declines by more than expected, companies can lose money on the transaction. Leases are a major driver of the sales of more expensive vehicles and have helped drive average transaction prices in the U.S. auto market by 13% to over $34,000.

This is why Ford has decided to cut down on the percentage of its retail sales that are made via the lease channel. In 2016, this number declined from 26% in the first quarter to 18% by the third quarter. As such, the company has guided that it expects $300 million less in profits from its Financial division this year. On a broader, industry wide level, We expect other developments of note. First, leases have been a driver of premium vehicle sales in the past, In fact, luxury vehicle makers rely on close to 70% of their retail sales to be via leases. Now this practice has crossed over to the mass market and is driving growth in the SUV, MPV and Crossover markets. These segments have been the main drivers of auto sales growth in the U.S. over the past three years as passenger vehicle sales have declined. Moreover, with auto makers cancelling their expansion plans of production plants which manufacture passenger vehicles, the reductio in leasing could result in a slow down of the auto market. Auto makers might try offsetting this slow down by offering incentives to drive vehicle sales, which could result in lower average transaction prices. The other possibility is that, in the absence of leases, consumers could start to gravitate towards newer financial models of car usage and ownership. Between outright purchasing and financing, a number of new business models to facilitate car usage are emerging. These range from the on-demand ride services offered by the likes of Uber and Lyft, rental models offered by car rental companies and monthly rent models such as the new Book by Cadillac offer. These could further accelerate the trends exhibited by the lower number of driving licenses being issued in the U.S. and lower number of average miles driven per vehicle.

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