RVI Bullish on Used Car Market

RVI Group (RVI) is predicting a 4.2% increase in the Used Car Consumer Price Index (CPI) for 2006, building on the strong showing of the 5.0% increase in 2005. “We believe that used vehicle prices will continue to improve in 2006 primarily due to low levels of used car supply,” notes Rene Abdalah of RVI Analytical Services. “Following 24 consecutive months of year-over-year declines in used vehicle supply (as measured by RVI’s Used Stock Index), we expect the first 6 months of the year continue to behave just as well for the industry. For 2006, on average, we expect used car prices to increase by 4.2% on a year-over-year basis.”

RVI’s Used Stock Index is inversely correlated with changes in used car prices. RVI Analytical Services developed its own “Used Vehicle Stock Index” in an attempt to capture changes in used vehicle supply relative to demand in a specific segment. By comparing current and expected future sales by segment to historical sales of that segment, RVI can get a reliable indication of which used vehicles will be in short vs. excess supply relative to demand, since used car demand by segment tracks new car demand closely.

The index represents the ratio between historical sales and recent sales (as a proxy for current demand for that segment) in each segment. Thus, if current demand exceeds historical sales, the index for that segment will be less than “1” and prices will be “strong” by historical standards.

“After experimenting with a number of measures of supply and demand that we thought might be good predictors of future used car prices, we derived the RVI Used Vehicle Stock Index,” notes Mr. Abdalah. Exhibit 7 shows the strong correlation we have found. The relationship between our Used Vehicle Stock Index and Used Vehicle Prices is quite remarkable. When our Used Vehicle Stock Index increases, Used Vehicle Prices decrease; which intuitively makes sense, i.e. when supply goes up, prices go down.

“The key going forward for predicting future residual values is the direction of change in the index for each segment, as well as specific models,” explains Mr. Abdalah. “We all know that the Luxury Sport Utilities (e.g., Volvo XC90), Luxury Sport Sedans (e.g. BMW X5 Series) and the Small Sport Utilities (e.g., Toyota RAV4) have performed great at auction recently due to the low levels of used vehicle supply. Our stock index for the first quarter of 2006 is 0.65 for Luxury Utilities, 0.61 for Luxury Sport Sedans and 0.75 for Small Sport Utilities, all significantly below the industry average of 0.97. (See Exhibit 8.)

Exhibit 8
Sample Segments from RVI Used Vehicle Stock Index
1st Q 2006

“However, the supply of all of these segments will increase rapidly in the near future. The supply of used Luxury Sport Utilities will grow very quickly even though future sales are predicted to exceed past sales in the segment for the next five years. Three, four and five years out (2009 – 2011), our Used Vehicle Luxury Sport Utility Index will be 30% or more higher (0.84, 0.95 and 0.92 compared to 0.65), which will have a strong negative effect on auction prices for the segment.”

Similarly, the index for Small Sport Utilities will also gradually increase over the next five years, even though future sales are also predicted to exceed past sales in the segment. In the first quarter of 2009, used vehicle supply will have increased by 10% (up to 0.85) to be followed by increases of 6% and 8% in 2010 and 2111, respectively.

The most dramatic increase in used car stock will be in the Luxury Sport Sedan segment. Currently, this segment has the lowest Used Car Stock Index: 0.61. However, in three years, used supply relative to demand will almost double to 1.12, an 84% increase. Lessors that project their future residuals for this segment based on current auction results may be in for a rude awakening.

On the other hand, subcompacts have strengthened due to the underlying demand for better fuel efficiency rather than a current shortage in supply compared to demand. But for the next two years, there will be a dramatic undersupply of used subcompacts causing the index to decline 42% in 2007 and another 11% in 2008. Prices should soar in the used car market if these demand projects are accurate. Thereafter, over the next three years (2009 – 2011) supply and demand will equalize rapidly and the index will post double digit increases each year until it exceeds 1.00 in 2011 indicating used car supply will exceed current demand in that year.

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(1) Because of seasonal variations, the most accurate way to track changes in the used car market is to make comparisons to the same month of the prior year, i.e., “year-over-year,” rather than comparing to the prior month.

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