ALG Forecasts 1.5% Increase for 2006 Used Car Prices

Following a strong (although volatile) recovery in 2005, Automotive Lease Guide projects a further 1.5% overall gain for used car prices in 2006. Citing R. L. Polk registration data (which tends to underestimate the percentage of retail leases in some states), ALG projects that 2006 will experience an increase in lease penetration of 1.4 percentage points from 15.4% to 16.8%.

ALG projects 12.4% increase in lease volume. Based on ALG’s assumptions that vehicle sales will increase to 17.4 million units and fleet sales will decline to 16.0% of new vehicle sales, new retail leases are predicted by ALG to increase 271,000 (about $8 billion) from 2.19 million to 2.45 million vehicles. “We think there is a growth opportunity in leasing for new entrants as well as established lessors due to higher interest costs, less loan rate subvention and more attractive lease payments due to stabilizing residual values,” explains Raj Sundaram, President of ALG. “We expect lease penetration to grow 2-4 ppts over the next few years and may approach 20%.

ALG carefully tracks fleet penetration rates. One key in picking the strongest brands in terms of value retention is the percentage of fleet sales. Exhibit 1 shows that overall fleet penetration has a fairly narrow range in recent years from a low of 14.6% in 1999 to a high of 16.5% in 2004. However, four of the highest selling domestic nameplates (Dodge, Chevrolet, Pontiac and Ford) exceeded 35% for the first 9 months of 2005, more than double the industry rate. (See Exhibit 2.) The only import on the top ten list was Mitsubishi, which actually reduced its fleet sales 12 percentage points from 2004.

Exhibit 3 shows the brands with the biggest increase in fleet sales in 2005. Saturn had by far the biggest increase, jumping more than 5 percentage points while only three other brands exceeded 2 percentage points. “We track both the overall fleet sales percentage as well as the annual change as an important part of gauging each brand’s used car supply,” notes Mr. Sundaram. “Increasing fleet penetration raises a red flag for us that we build into our depreciation/value retention predictions. Although decreases in fleet penetration will result in some improvement of residual values, the new products of these manufacturers need to be successful to see a material move.”

ALG predicts that used car prices will increase in 2006 while new car prices decline. At first glance, there seems to be an inconsistency between ALG’s prediction that the New Vehicle Consumer Price Index will go down 1.5% in 2006 while used vehicles prices go up 1.5%. “This apparent disconnect is explained by looking more closely at used car supply,” says Mr. Sundaram. “The biggest overall factor driving used car prices is supply and demand. The used car recovery in 2005 was fueled by the 1.9% decline in used car supply. That trend will continue in 2006 with another slightly large decline of about 2% in the used car supply. That’s the benefit of the reduced leasing volume in 2002 and 2003 and the longer lease and retail loans that have evolved.”

The other key variables related to the future direction of used car prices are the level of 2006 sales and the success of GM’s value pricing plan to maintain “net prices” at 2005 levels while stabilizing demand. “We are skeptical about GM’s success based on recent history and will monitor the performance over the next 6-12 months. There’s too much consumer experience with waiting for the next major GM incentive plan to think that consumers will accept a permanent change in GM’s marketing strategy in a matter of months. While the GM incentives may be more targeted and directed more at leasing and retail rates than in the past, it is likely that GM net prices will decline in 2006, which will continue to keep a lid on used vehicle prices,” predicts Mr. Sundaram. However, if the pricing strategy is successful and results in significantly lower incentives, used vehicle values will be strong and may outperform 2005 performance, especially for GM vehicles. Furthermore, GM’s value pricing plan is expected to force other manufacturers to follow suit, as many did in 2005 with incentive programs. “Ford and some of the Asian manufacturers are already showing evidence of this trend with some of their new launches,” states Sundaram.

ALG’s overall historical RV projections show net gains for 2006. Looking ahead to the overall used car market performance versus the historical ALG projections, ALG believes that 2006 should largely mirror 2005. “Our 2002 36-month industry composite RV percentage of 43.5% was 3.1 ppt less than the actual 46.6% achieved by the used car market. (See Exhibit 4.) That was the first time since our 1996 projections that the market exceeded our projections on the majority of vehicles. We project an even bigger gain in 2006 since our composite RV projection declined to 42.0% while the market should average 45.8%, 3.8 percentage points of MSRP higher or more than $1,000 on a typical $28,000 MSRP lease.”

The 48-month ALG RV performance should also continue from 2005 into 2006. “Unfortunately, the 48-month used car market has not held up as well as the 36-month, Mr. Sundaram notes. (See Exhibit 5.) However, for the 2002 models terminating in 2006, the gap is only 0.6% of MSRP on average (38.2% vs. 38.8% predicted).

ALG has almost doubled its depreciation rates on three year old vehicles since 2003. “We have incorporated a major increase in the depreciation rates for 3 yr old vehicles in the last 5 years, primarily due to the product cycle shrinking from 5 years to 3 years for most manufacturers. Now, the 3+ year old vehicle (the ‘old design’) is competing with or will soon be competing with the ‘new redesigned model.’ Since 1996, the gap between the 3 and 4 year old used car values has been much greater than it had been historically. (See Exhibit 6.) Since 2003 we have almost doubled our spread between the 36-month and 48-month residuals from 4.4% to 8.4%, i.e., virtually doubling the expected depreciation rate.”

Exhibit 6 shows the difference between ALG’s 36-month and 48-month industry composite residual values versus the actual difference that occurred. The dotted line represents ALG’s expected RV difference (derived from Exhibits 4 and 5) between the 36-month and 48-month residuals. For example, for 1996, Exhibit 4 shows the 36-month ALG composite residual value to be 51.2% while Exhibit 5 shows the 48-month ALG composite RV to be 44.4%, a 6.8% difference. However, the bars on Exhibits 4 and 5 show that the “actual” RV was 52.0% for the 36-month RV but only 43.6% for the 48-month RV, an 8.4% difference. ALG thus understated the 36-month to 48-month RV percentage decline on the 1996 models by 1.6%, i.e., 1.6 percentage points of MSRP. It is this effect that has kept the 48-month ALG RV’s in negative territory despite the fact that the 36-month ALG RV’s were strongly positive in 2005 and are projected to remain strongly positive in 2006.

In terms of the new vehicle market, ALG expects:

		Pull ahead sales over the last few years and rising interest rates will increase the volatility of new vehicle prices.
		The effects of the 2005 employee pricing programs will lead to more aggressive pricing on 2006 models, producing 1.5% of decline in new car prices in 2006.
		With rising interest rates and relatively stable residuals, industry lease penetration will rise 2-3 percentage points (ppts) in 2006-07.
		Value/market based pricing strategies will optimize/maximize residuals.
		Remarketing will continue to be more integrated with new vehicle marketing/sales.

In terms of the used vehicle market, ALG expects:

		2006MY residuals to be lower by about 1 ppt compared with the 2005MY.
		Luxury segments to deteriorate at a faster rate than the industry average.
		Resale values to rise 1.5% - 3% in 2006-07 and start declining in 2008.
		Premium luxury, Full Size Cars, Mid-Full Size SUVs and Full Size Pickup residuals values to decline at a faster rate than the industry average. Mid-Compact Cars and Premium CUV’s(3) with 7 seats to show the strongest performance.
		Value pricing to be tested and if sustained to result in strong residual improvement for the domestic brands
		Import brands to be mixed in 2006. Domestic brands will have more upside in 2006 if the new vehicle launches are successful. Nissan and VW will be the weakest. Hyundai is positioned to show the most improvement.
		Japanese Luxury brands will continue to gain ground on the European brands. Land Rover is positioned to show the most improvement.

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(1) While many analysts are projecting between 16.7 and 17.0 million new units in 2006, ALG’s forecast is supply-based and reflects the outlook and plans that have been shared by the manufacturers. Thus, ALG expects manufacturers to use incentives as needed to reach the 17.4 million sales level.
(2) Percentage points of retail sales.
(3) Crossover Utility VehiclesSend us your comments on this article »