Autos Must Pivot as U.S. Incomes Fall to 1995 Levels

By Chris Marasco - September 19, 2012 | Tickers: ETN, F, GM | 0 Comments

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Times are tough in the U.S., and American business could be crippled as a result.

The U.S. Census Bureau reports that median household income has fallen to $50,054 in 2011 from an all-time high of $54,932 in 1999.  The slide was the fourth straight year that U.S. incomes have fallen.

Also, The Wall Street Journal reports that the poverty rate – when families of four earn less than $23,021 – held steady at 15%.  For comparison, the rate was 12.5% in 2007 before the economic downturn.

On a positive note, the number of Americans without health insurance fell from 50.0 million to 48.6 million, pushing the uninsured rate down from 16.3% to 15.7%.  However, the drop could produce a false confidence – the number of people covered by government health plans shot up to 32.2% from 31.2%, perhaps leaving taxpayers to foot the bill.

The question for today’s industries is how to best position their businesses around this data.  Below are ways that automobile manufacturers can respond.

A Graceful Pivot

Ford (NYSE: F) and General Motors (NYSE: GM) already have their hands full with the European economic decline.  To combat weak markets in Europe, the firms are shuttering plants, laying off workers, and moving operations back to the U.S.  Exporting cars has proven to be a better tactic, and the firms even benefit from the United States’ weak dollar.  Especially scary is that Ford lost $404 million in Europe last quarter.

Lastly, if inflation roars its head the auto companies will see their material costs soar, and they will not be in a strong position to pass these costs on to consumers.  How can they respond?  There are two potential pivots – first is catering to consumers and second is catering to the commercial sector.

First, Ford and GM can shift their business to produce slightly higher-end, luxury vehicles in hopes of attracting the upper-middle class and wealthy customers.  In theory the strategy sounds feasible.  But in practice Ford and GM vehicles are hardly displays of wealth, something that many of the rich seek out.

Also, the companies could cater to the lower-income.  This approach would force the firms to significantly lower costs and to procure less-expensive materials for vehicles.  In order to sell the vehicles, the companies would need attractive financing packages – not hard in today’s low interest rate environment.  However, a bout of inflation, or even competitors lowering their prices, could derail this tactic. 

Finally, the autos can keep the same consumer strategy and focus on the commercial sector.  This strategy would include increased marketing and visibility in the B2B space, a ramped up sales force, and strong financing incentives to get firms to trade in their old vans and trucks for new. 

While American income has declined, corporations are hoarding cash – if Ford and GM can structure ways to move product, perhaps by catering to the tax incentives that interest payments boast, it can weather the short-term consumer spending storm.

Additional Thought – Think Vertically

Thinking through the implications of consumer income on the auto sector is important – but do not forget the suppliers of the major autos.  For example, Eaton Corp (NYSE: ETN) is a diversified industrial company, and part of its business is supplying drive train and other parts to commercial and passenger automobiles.  Eaton Corporation is a strong stock with a dividend yield of 3.2% and a price to earnings ratio of 11.5.

However, when the auto market sours, its suppliers also take a hit because the auto manufacturers produce fewer vehicles.  This means that Eaton Corporation sells less drive trains and electrical switches to Ford and GM.  Of course Eaton is a diversified enough company that slumping auto sales will not derail its stock price, but they could put a small dent in the company’s earnings. 

Conclusion

In all, remember that it is important to think through the implications of consumer patterns on different industries and to understand which options these firms can take as a result of the new data.  Further, remember to think through these implications across different verticals. 

Consumers make less money, so one implication is that they will not buy new cars.  Who else gets hurt?  Suppliers for those automakers – like Eaton.

Of course U.S. incomes falling to 1995 levels is a major hit to consumer-type companies, and it is important to understand which companies will be least and most affected by the change.  But remember that business is a chain of interconnected parts – when one industry is affected, so are the supporting segments.

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