Canadian Black Book: COVID-19 Automotive Market Update – 7/14/20
July 14 2020
The latest statistics published this past weekend show a great deal of favorable progress in the battle against COVID-19 nationally. Currently, there are over 27,000 active cases of the virus in Canada. Saturday saw 221 new cases reported, which is just a little more than one-tenth of the typical daily reports back in April and May. This is a testament to all the hard work of our front-line medical workers and the general public’s adaptation to new ways of daily life. A large portion of those fresh cases, almost 60% of them, originate in Ontario. With many cities/regions in Ontario making mask use in public places mandatory, the spread of the virus is expected to continue to diminish. How well the nation combats the virus and prevents additional waves has a direct impact on Canada’s economic wellbeing and the state of our auto sector.
Each week, we track and report on the value change of 2012-2018 model year vehicles. Adjustments are made in this data to compensate for changes in vehicle condition. The intent is to prevent vehicle mileage trends from influencing the reported value change metrics. If we do not consider this factor, vehicle values can be seen as improving. However, it is the quality of the used vehicles sold that is improving. With fewer kilometers being driven by much of the population currently, it is reasonable to expect that the average household mileage levels will drop this year. Last week, we saw wholesale prices remain remarkably stable. Car segments showed only a small 0.03% decline after two weeks of positive gains. Of the nine car segments, five were up for the week and four showed decreases. The largest improvement of 0.60% was from the Near Luxury Car segment. The biggest decline was the Prestige Luxury Car segment at -0.86%.
Truck segments showed a similar marginal decline of 0.05%, after last week’s gain of 0.18%. Reviewing the 13 Truck/Crossover/SUV segments that Canadian Black Book tracks, seven were down and six showed gains for the week. It was the Sub-Compact Luxury Crossover/SUV class that gained the most at 0.74%. and the Full-Size Crossover/SUV was the weakest performer, with a loss of 0.40% in value.
This recent deceleration in the decline of values reflects some supply shortages in the marketplace that will be temporary in nature. With dealer operations normalizing, inventory is becoming tighter as more vehicles move off the lot. As larger numbers of leases are concluded, repossessions resume, and fleets liquidate assets, we expect growing supply for both wholesale and retail operations.
A pivotal disruptor of the used vehicle marketplace, which we are carefully monitoring, is the impact of the now acted into force Canada-United States-Mexico Agreement (CUSMA) on trade. With a new set of rules in place, and the NAFTA certification that allowed certain vehicles to cross to border without tariffs rendered invalid, we do expect this to have an effect on a select set of wholesale used prices in Canada. Vehicles that were manufactured in the U.S. are expected to be handled as goods returning to their country of origin, so they would cross the border without tax. If an exporter cannot prove to the U.S. government that a vehicle they are exporting complies with the new CUSMA rules, the vehicle would be subject to an import tax. For most passenger vehicles manufactured outside of the U.S. the tariff would be 2.5% of the declared value. However, for pickup trucks and SUV/Vans with just two seats, these vehicles are expected to be subject to a 25% tariff. This makes vehicles taxed at 25% with a VIN that commences with 2 (for Canada) or 3A through 3W (for Mexico), poor candidates for export to the U.S. market.
Unless the local Canadian market can absorb these vehicles that are undesirable for export, the values at wholesale will fall. This could be a dose of good news for many Canadian retailers who, for many years, have been outbid at auction while trying to acquire pick-up trucks for their lots. Any Mexican made or Canadian made pickup trucks will most likely remain in the country unless exporters are able to prove CUSMA compliance, which may be next to impossible without the direct support of the OEM’s factory.
Last week, the Canadian Federal Government provided their Fiscal Snapshot which illustrates the extent of the COVID-19 related damage to our economy and the government ledgers. The expectation is that there will be two million Canadians unemployed and slow growth until the end of 2021. For 2020, the government expects the unemployment rate to hit 9.8%, dropping to an improved 7.8% next year based on forecasts by private sector economists. The $80-billion Canada Emergency Response Benefit (CERB) has paid out $53.5 billion in benefits, as of late June. It has covered Canadians’ estimated $44.6 billion in lost labour income through the first half of the year. The government deficit is now expected to be a historic high of $343.2 billion. The cost of COVID is now at $231.9 billion in direct spending and a deficit comparable only to those seen during the Second World War.
A full recovery is not seen as possible until an effective vaccine or treatment becomes widely available and is deployed to the population. The Federal Government is concerned that the COVID-19 situation could worsen if two scenarios come into reality. If prolonged shutdowns or restrictions remain in place, a return to normal activity for the economy will be volatile and slower than hoped for. This will lead to a more pronounced drop in GDP than is already expected. If the country is hit with a second wave of the virus during the annual flu season, the ensuing lockdowns would cause what the Finance Department describes as a deeper and longer-lasting negative impact on the economy. This outlook aligns with our own Most Likely Scenario and Severe Recessions Scenario for CBB’s residual value forecast outlook. There is optimism that the Most Likely Scenario will prevail given the current status of the virus in Canada. However, if our ability to manage the crisis is not effective, the Severe Recession Scenario could come into play.
CURRENT WHOLESALE MARKET OVERVIEW
Canadian Black Book’s Automotive Analyst team has a combined 70+ years of insight and experience in the automotive industry. Through ongoing communication with dealers, remarketers, finance companies and vehicle manufacturers, our analysts track vehicle prices in order to independently chart and report the market via daily price updates. In addition, our survey personnel attend (virtually at the present time) major auctions in Canada each week.
• The various digital auctions have virtual exclusivity on the wholesale market in Canada. • The first full week in July continued to see lots of activity in the lanes. In many cases, the number of bidders were almost 10x the pre-COVID norms. • There remains one physical auction operating in, Quebec, and two independent auctions in Eastern Canada. • Given the many health and safety concerns around operating physical auctions, to protect bidders and auction employees, it might be some time before the larger facilities are able to run vehicles in the lanes.
Last week was the first full working week of July, and auction operations were back to a normal schedule with some higher volume results. Volumes were up, yet not near normal pre-pandemic levels. Certainly, as time goes forward, we expect overall volume at auction to grow and perhaps exceed normal summertime levels this year. During the months of March through May, minimal trade-in activity, lease return activity, and virtually zero repossessions had sharply decreased supply nationally. With pent-up demand in the marketplace materializing, more trade-in activity beginning to occur, and increasing lease returns and repossessions, Canadian Black Book is expecting overall volume to be strong over the next few months.
Last week we noted that the trend of incredibly strong sales rates had continued. On occasion, our team has witnessed auctions where the rate is lower, however, over 80% sales rates were quite common this past week. Bidders are working hard to source inventory to replenish stock, and we have seen significant optimism regarding the overall market at this time. Typically, April through June are the strongest retail months in Canada, and they make up 30% of annual sales. Certainly, the normal swings of seasonality are not to be expected in 2020. As consumer confidence builds in the coming months, it is quite feasible that the sales rate will continue to strengthen later in 2020, outside of the well-established seasonal norms.
CURRENT WHOLESALE PRICE TRENDS
Market Level View
Volume-weighted, overall car segment values fell by 0.03% this past week for 2012 to 2018 model year vehicles. This negative adjustment is noteworthy as it shows that stability in prices has continued into a second week after more than three months of sharp decline in values. As a reminder, last week saw a 0.02% increase. Of the nine car segments, four increased and five showed decreases. The steepest declines are at opposite ends of the car price spectrum. Prestige Luxury Cars were -0.86% lower for the week and Sub-Compact Cars sunk by -0.46%. Near Luxury Cars, the entry level luxury car segment, gained 0.60% for the week, making it the leader within car segments.
When volume-weighting is applied, overall Truck segments (including pickups, SUVs, and vans) had a similar story to what cars experienced. A modest 0.05% decline continues the market pause in dramatic value declines for the segments. Last week’s results did not continue the trend of the prior week’s impressive 0.18% lift. The coming weeks will confirm if trucks will remain flat and stable or if we will see continued declines, which is Canadian Black Book’s expectation. The 13 Truck/SUV/Van/Crossover segments were almost evenly split with six posting gains and seven being down last week.
The biggest increase for the week was seen in the Sub-Compact Luxury Crossover/SUV segment at 0.74%. The other segments that had increases only saw small improvements from 0.01% to 0.10%. The largest declines were witnessed by Full-Size Crossover/SUVs at 0.40%. Full-Size Pickup trucks were up by 0.10% last week, and their smaller siblings, the Small Pickup Trucks were up by 0.06%. New export guidelines under the USMCA free trade agreement are expected to see Canadian and Mexican made pickup trucks and two seat vans to be taxed by 25% if exported to the U.S. This is expected to selectively drive down values for those vehicles that were not made in the U.S.A. as it would be unlikely that they would be exported as used units any longer, unless the tariff rules change.
The graph provided below (Canada – Weighted % Change in Value by Segment for 2- to 8-year old models) illustrates the week-over-week depreciation rates, expressed in percent, for the entire market. Cars are displayed in blue and light trucks are shown in red (represents Vans, SUV/Crossovers and Pickup Trucks). The data set commences in March of 2020, just before the impact of the COVID-19 virus. The past three weeks clearly illustrate a major shift in value trending, as shown in the graph. From March until two weeks ago, declines on a weekly basis were much steeper than normally expected in the market. This reflects downward pressure on prices during the pandemic crisis. It is our opinion that recent strengthening in value is temporary until such time that levels of supply in the wholesale market grow.
Segment Highlight – Prestige Luxury Car
Simply put, cars are not as popular as trucks, crossovers and SUVs in Canada. This is not a new trend. In June, DesRosiers Automotive Consultants reported that, for the first half of 2020, light trucks accounted for a 78.9% of total market sales, while passenger cars only made up 21.1% at the half year mark. The peak share for cars in the market was 1960 according to Statistics Canada. Since that time, the number of other options for potential car buyers has grown significantly. In 2009, the two shares “crossed over” when both held 50% of the market. The following 11 years have greatly strengthened the trend away from cars. Luxury segments are no exception to this fundamental shift. It has become increasingly rare to see high end luxury cars on the road. In this segment, we include notable models such as Mercedes-Benz S-Class, BMW 7 Series, Jaguar XJ and Audi A8. These are all brilliant vehicles, yet their popularity in terms of volumes sold continues to fall, replaced by ultra-luxurious and more spacious SUV/Crossover offerings.
Since these vehicles have become less desirable in both the new and used market, they can often make for attractive bargains in the secondary market. They certainly are not inexpensive from a purchase price perspective but are at a great discount compared to their often six-figure MSRP. After four years on average, these vehicles retain just 45% of their original MSRP. There is always some risk of an expensive ownership experience from a maintenance and repair standpoint. Acquiring one of these through an OEM’s Certified Pre-Owned program with some of the original warranty or the extra coverage of a reputable aftermarket coverage is a wise idea.
Last week, the Prestige Luxury Car segment was down by 0.86%, the largest decliner across cars, which all together were only down by 0.03%. However, this segment seems to be defying the COVID-19 gravity pull that has brought down prices for most of the industry. It is only down 1 Index point since March and only down 0.3 of an Index point since January, making it one of the best performing segments during that time. The retained value percentage peaked at the beginning of 2018 and is only 7.4 Index points lower this past June.
Last year, when we announced the CBB Best Retained Value Award winners, it was the Porsche Panamera that won the top prize for the class. In second place was the Mercedes-Benz S-Class, followed by the Lexus LS Series.
Over time there is some risk that this segment may almost vanish. As so many OEMs retool for EVs, the expectation is that many of the new EV offerings will be SUV/Crossover inspired products and not the autobahn prowling sedan products.
USED WHOLESALE PRICE PROJECTIONS
Wholesale Price Impact Under the Most-Likely Economic Scenario
Although we have seen the price declines slow down dramatically in recent weeks, the instability caused by the impact of COVID-19 remains. For June, the decline of our Value Retention Index was a very slender 0.01 Index points. This puts the Index 5.6% lower than one year ago. As a reminder, wholesale prices were down 0.99% in March, 3.58% in April, and just over 3% for May.
Canadian Black Book’s outlook reflects a new economic reality – our team expects that projected values will continue to stay well below pre-COVID-19 projections over the next two years.
Short-Term Outlook (Summer/Fall of 2020)
We project a drop in wholesale prices compared to a pre-COVID-19 baseline this summer/fall as the Canadian economy suffers through the effects of COVID-19. We anticipate that wholesale prices will be 17% lower, on average, compared to pre-COVID-19 projections, during the remaining months of 2020. We expect to see continued declines over the summer with recovery commencing early in 2021. We also anticipate that older (more than six-years-old), less expensive vehicles in average condition will not decline as much due to increased demand for these units. The selective demand lift is expected to be driven by consumers seeking low cost, reliable transportation. COVID-19 and the resulting social distancing practices are expected to cause some regular transit riders and ride sharing customers transition to vehicle ownership which will fuel some incremental industry sales.
Long-Term Projections (36-Month Residual Values, Summer / Fall of 2023)
The effects of the pandemic will continue to be felt three years from now. However, we project that residual values will return to the pre-COVID-19 baseline as used supply will decline as a result of lost retail and fleet sales throughout the remainder of 2020 and into 2021.
Wholesale Price Impact Under a Severe Recession Scenario
In this scenario, we project a 25% drop in wholesale prices compared to a pre-COVID-19 baseline this summer/ fall, with a very slow recovery in 2021. The effects of the pandemic and recession will still be impactful in 36 months, and we project a 10% market level decline of wholesale prices as compared to pre-COVID-19 projections for the second half of 2023. The differentiating factor between CBB’s Most Likely Scenario and the Severe Recession Scenario is our success at combating the spread of the virus. If a particularly large subsequent wave of COVID-19, or waves, were to push parts of the economy into lockdown mode, the recession would deepen further.
In the first week of July, retail asking prices continue to show some downward movement but only by a very small amount. This analysis is based on CBB’s daily review of vehicles listed for sale by retailers in Canada. Although prices at wholesale have fallen 7.2% since March, we still have not seen asking prices in the market follow. The fourteen-day moving average prices, marked in green in the graph below, have increased almost 2% since early May, yet are only beginning to show weakness in recent weeks. It is our expectation that retail asking prices will decline. Given the recession at hand, there will be weaker consumer demand and a greater supply of vehicles due to repossessions, divesting of rental units and a surplus of lease return units.
• Coming off a healthier June which only saw a decline of 16.2% in sales (a major improvement compared to the -75% of April) we expect to see less pent-up demand in July and August. This will provide some clarity as to what the sales pace will be for the remainder of 2020. • We are more than halfway through 2020, and sales are 34% lower than the same time in 2019. It is the expectation of the CBB team that new car retail sales will end the year down by 25% from 2019 levels. • The tremendous disruption to new vehicle production will continue to be a factor in 2020, as retailers who did enjoy strong new car sales in June may now struggle to source new units for July until production is fully restored. Just this past week, media had reported that Ford felt the current enforced limit on some of its Mexican production facilities was not sustainable. In these facilities, only 50% of the workforce is present at one time. It is reasonable to expect that shortages and production stoppages will occur until a vaccine is developed and widely deployed.
New Vehicles Sales Outlook
Our New Sales Outlook remains unchanged from our last update. We anticipate a significant reduction in Canadian new vehicle sales in 2020 (both retail and fleet sales) due to weaker overall demand. This is the result of several factors, including fewer kilometers driven due to remote work arrangements and lockdown initiatives, high unemployment, and a severe erosion of consumer confidence. New sales were down 34% during the first six months of the year compared to last year. July and August will be telling months as there is expected to be fewer units sold due to pent-up demand, in the monthly sales results.
In our base economic scenario (A), we project a 25% drop (compared to pre-COVID-19 projections) in new sales in 2020, to 1.436 million units. In a deep economic recession scenario (B), we project a 40% drop in new sales in 2020 to 1.149 million units. The deep recession, if it were to occur, would be brought on by extended lockdown measures due to multiple waves of COVID-19. In the longer-term, we expect new sales volume to return to pre-COVID-19 levels within five years. At this point in time, it appears that our Scenario A is the more probable one, unless of course there is a large resurgence of the virus in the coming months.
USED VEHICLE SUPPLY PROJECTIONS
Canadian Black Book maintains our projection of dramatically higher used vehicle supply in the wholesale marketplace for the coming months due to several factors: • Delayed lease returns resulting from lease term extensions offered by OEMs are now coming back to market. • Extensive de-fleeting by rental car companies due to lack of consumer demand in the travel sector will continue, however it is expected that these firms will try to do so slowly and strategically to avoid flooding the market and thereby reducing their own proceeds at wholesale auction. • Increased repossessions due to deteriorating economic conditions have commenced. It will take several months for the industry to be fully caught up with vehicles that need to be secured and sold. • In Canada, 2020 and 2021 were already larger years for lease maturity volumes, with falling values and economic uncertainty this may push lease return rates up, due to fewer buyouts by lease holders. • There is the expectation of a reduction in the size of corporate fleets due to smaller operations and the desire to free up cash.
Short Term Lease Return Projections
When we began this year, lease maturities were projected to hit a record volume of more than 400,000 units for the year. Once the pandemic was underway and most manufacturing stopped, OEMs worked to facilitate lease extensions in order to push returns further into 2020 when they would be able to reliably provide replacement vehicles. As a result, we project at least 60% more units will arrive in the second part of 2020 (compared to the pre-COVID-19 estimates) due to a slowdown in sales in March/April/May, along with expected turn-ins of the lease extensions.
Rental Unit Returns
Business and leisure travel collapsed at the end of March and remains grounded. We expect a significant reduction in both categories for the remainder of 2020. Air travel has fallen by more than 90% in Canada. In addition, there is no expectation that travel will return to pre-COVID-19 levels in the next several years. According to IATA (The International Air Transport Association), air travel will not return to pre-COVID-19 levels until after 2023. This puts tremendous financial pressure on rental companies that rely on air travel to reduce both their current fleet and future vehicle acquisitions.
On May 22, Hertz filed for bankruptcy in North America as a result of the pandemic. Media in the U.S. report that Hertz plans to sell some 30,000 vehicles per month to satisfy its creditors once the plan is approved. Its total U.S. fleet is over 500,000 vehicles. The fleet size in Canada is unknown from public data sources. In a typical year in Canada, over 200,000 rental vehicles are sold to rental firms. Generally, rental car operators keep these vehicles 12 to 18 months until they reenter the market as used vehicles. If rental car players remarket these vehicles in large numbers earlier than expected, it will apply additional downward pressure on prices, due to the sudden influx of supply.
In addition to Hertz, we do expect other car rental companies to reduce their fleet during the summer and fall months to match lower demand for airport rentals. This practice will lead to over 25,000 additional rental units hitting the wholesale market over the next six months.
Longer Term Used Returns Projections
With the reduction in retail and fleet sales over the next several years, we project approximately 8,000 fewer used units per month in the market in three years, compared to previously projected returns. This lower level of used inventory will be beneficial to used car prices as supply will be limited.
Given the economic situation Canada is facing, it is regrettable that default rates on vehicle leases and loans will rise. In June, Equifax reported that it expected delinquencies on debts of all types to rise by 25% in the next six months. Eventually, some of these delinquencies will lead to repossessions. These repossessions will push more vehicles to auction and, ultimately, the secondary market, increasing the supply of vehicles available for sale.