NEW YORK (The Deal) -- The North American auto industry has engineered an impressive recovery since the dark days of the Great Recession. But its rally-fueled expansion -- the fastest since a post-World War II boom -- could cause issues for investors as automakers chase increased sales.
Auto sales are headed toward an annualized rate of 17 million units, a remarkable turnaround from 10.4 million units sold in 2009. Automakers who cut aggressively during the downturn have responded by adding shifts and expanding plants, spending billions in the process.
Investors have noticed. Shares of Wall Street darling Ford Motor (F), for example, have almost doubled since the beginning of 2010.
There's an adage in the highly cyclical auto business that when manufacturers start adding third shifts, it is time to sell. Though it can be argued that streamlined automakers are better-positioned to handle a speed bump now than they were in years past, increased capacity tends to put pressure on pricing. It might be time to adjust expectations accordingly. Morgan Stanley analyst Adam Jonas says that while there are a lot of good things happening in the U.S. industry, "there are just too many car companies chasing too few consumers." Jonas stresses he is not trying to call a top to the rally, but says it is time to reconsider "too-optimistic 2014 forecasts" to allow for expected competitive price pressure and other potential issues. A 1% cut in U.S. pricing translates to a 10% to 15% cut in North American profits, the analyst says. Industry bulls will counter that much of the growth this time around is smart growth, and can more easily be pulled back should sales slow or prices come under pressure. A significant portion of the additional capacity is in Mexico, where costs are lower and labor is more flexible, and even in the U.S. and Canada manufacturers are taking advantage of reworked labor deals that allow for more liberal use of so-called Tier 2 lower-cost employees. Bulls also note that automakers have been careful to limit infrastructure investment, instead increasing output at existing facilities, and point to Europe as a potential offset to any slowdown in the U.S.
But adding shifts is still expensive. Jonas says Ford spent about $9 billion from 2010 to May 2012 on retooling, revamping and adding capacity in the U.S. and Canada despite not breaking ground on a new facility. And skeptics say that even if automakers succeed in pushing billions in European losses into the rear view mirror, there are no guarantees buyers in the mass transit-friendly region will return to showrooms en masse.
The auto industry has come a long way in a short amount of time, and no one is expecting a repeat of the 2009 crash and subsequent bailouts. But at some point the growth will inevitably stall. That day could be right around the corner.
-- Written by Lou Whiteman in New York
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