Canadian Black Book: COVID-19 Automotive Market Update July 21, 2020

July 21 2020
CBB

Canadian Black Book COVID-19 Market Update

SUMMARY

As we enter the second half of July, , we continue to see wholesale prices in the Canadian marketplace stabilize after the sharp downward trend that began in March. At large, the nation remains cautiously optimistic in the battle against COVID-19. Each passing day brings to light healthcare results that show that Canada is moving in a positive direction with fewer cases of COVID-19 and fewer patients in critical care. Last week, on average, fewer than 380 cases were reported daily across Canada. With an increasing number of Canadians, either voluntarily or due to local regulations, adopting mask wearing in public, health experts believe we can slow the spread and eventually halt the pandemic.

However, as the economy more widely opens and our day-to-day interactions with others returns to more normal levels, the risk of a secondary wave of outbreaks rises. Such secondary outbreaks have been seen in other locales around the world that had previously battled the virus and then embarked on a swift return to more normal daily life. For example, last week, parts of Spain and in the Xinjiang region of China have seen restrictions return due to a spike in new cases. If Canadians fail to adhere to social distancing, mask wearing, and other preventative measures, we could risk further COVID-19 spread and damage to our struggling economy.

The month of July, in more conventional times, makes up approximately 9% of new car sales for the year. Sales results from the months of May and June of 2020 were generally agreed by most in the industry to have been propped up by a considerable amount of pent-up demand from earlier, stagnant sales months, for new and used vehicle sales. As we get further away from those months, Canadian Black Book expects to see more clearly what the natural levels of demand through this COVID-19 recession will be.

Last week, we saw wholesale prices continue trends toward stability that have defined the month of July thus far. Car segments showed a small 0.10% increase in wholesale value. This follows the previous week’s slight decrease of 0.03%. Of the nine Car segments, five were up for the week and four showed declines. The largest improvement of 0.64% was from the Full-Size Car segment, while the most significant decline was seen in the Luxury Car segment at -0.23%.

Truck segments showed a small drop of 0.14%, which follows the previous week’s 0.05% decline. Overall, the thirteen Truck/Crossover/SUV segments tracked by Canadian Black Book saw declines in all but two. The two gainers were the Compact Crossover/SUV segments (up by 0.30%) and the Sub-Compact Crossover segment(up by 0.29%). The two weakest segments over the past week were Minivan at -0.51% followed by Sub-Compact Luxury Crossover at -0.48%.

Canadian Black Book believes that the recent strengthening of the market, as it reopens, has created tight used vehicle supply in almost every segment. This reduction of inventory levels, on dealers’ lots, and those available for wholesale, has caused prices to temporarily pause their weakening. In the coming weeks and months more repossessions, deferred lease returns, and fleets downsizing will raise supply levels. How much demand will exist remains uncertain for the rest of 2020 and into 2021 when the economy, presumably, will be well on its way to a lasting recovery.

Last week, the Bank of Canada announced their most recent Monetary Policy Report (MRP), as well as their latest interest rate setting news. During recessionary times, these updates from the Canadian central bank have proven to be even more crucial. The MPR provides insights into the monetary oil that keeps the economic gears of the nation rotating, albeit with a monkey wrench thrown in this year. Not surprisingly, the bank maintained its target for the overnight rate at the effective lower bound rate of ¼ percent. The Bank also shared that it is continuing its quantitative easing program, with large-scale asset purchases of at least $5 billion per week of Canadian Government bonds. The bank also continues to purchase both provincial and corporate bonds to ensure there is sufficient cash available in the economy. The Bank’s short-term liquidity initiatives announced in March are working as expected. This helps to avoid the credit crunch that existed during the 2008/2009 recession.

While many economies around the world begin to get back on their feet, the future remains extremely uncertain, given the unpredictability of the COVID-19 pandemic. The Bank of Canada’s primary forward-looking scenario (called the central scenario) assumes that there is not a widespread second wave of the virus here at home. The bank expects the global economy to shrink by about 5% in 2020, followed by growth of 5% on average for the next two years. The Canadian economy is slowly starting to recover as it re-boots from the shutdowns needed to protect the public from the virus. Canadian economic activity in Q2 is estimated to have been down 15% since the end of 2019. This equates to the largest decline in economic activity since the Great Depression

There are positive indications that commerce is resuming, and the collective pent-up demand for goods and services is leading to an initial bounce-back in employment rates and GDP output. In the Bank’s central scenario, roughly 40% of the collapse in the first half of the year will be made up in the third quarter. The Bank expects the economy’s recuperation to be slow, as the pandemic continues to affect confidence and consumer behavior. In the Bank’s favored central scenario, Canadian GDP declines by 7.8% in 2020 and resumes with growth of 5.1% in 2021 and 3.7% in
2022. The Bank of Canada will make their next interest rate announcement on
September 9, and the next MPR on October 28 of this year.

The Conference Board of Canada also reported some positive news this week in their June Labour Force Survey. The summary of their report reads, “In another sign Canada’s economy is on the path to recovery, employment rose by a record 952,900 in June. The rebound was concentrated in services, part-time and low-wage jobs—a partial recovery in the same segments that were hardest hit by the pandemic. Despite the solid gains in June, Canada’s economy still has a long road back to recovery. Employment is still down 1.8 million when compared to pre-pandemic levels, with the largest gaps in industries that will not recover .”

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.

Auction Insights

• The various digital auctions have virtual exclusivity on the wholesale market in Canada, with the majority of physical auctions closed since March.
• Currently there is one physical auction operating in Quebec and two independent auctions in Eastern Canada.
• Now that we are halfway through July, wholesale price trends seem to be consistent with those seen last month.
• There remains an impressive amount of activity in the virtual lanes. In most cases, the number of bidders participating is very high, a positive sign for sellers.
• It is not expected that the large auctions in the major population centers, will be reopening anytime soon due to the risks posed by the virus to staff and clients.

Auction Volume

Auction volumes have continued to be stable so far this month. It is our estimate that even given all the restrictions and reliance on online only options, auctions are putting through between 70-80% of the volume of vehicles they had in pre-COVID times. It is our expectation that as we continue through the summer, overall volume at auction will grow and perhaps exceed levels this year versus last year. Currently, however, overall supply in the market remains tight and many retailers are retaining trade-ins rather than sending them out to the wholesale market. Since the beginning of the crisis through May, minimal trade-in activity, lease return activity, and virtually zero repossessions reduced the number of vehicles available for sale at wholesale. We are expecting more repossessions, not just for the summer months but for the duration of 2020. The return of repos, along with some downsizing of corporate fleets, will help to provide more stock in the coming months.

Sales Rate

Sales rates continued to stay strong this past week and, in most cases, higher than what was the norm before COVID. In pre-pandemic days around 70% was the standard at live auctions. During the past week our team noted a range, as low as 40% to a high of just over 90%. Either way, sales rates remain outstanding. It is a testament of the market appetite to to fill empty spots on lots across Canada. Low sales rates usually signal that sellers have reserves that are too optimistic or are not willing to be flexible when there is money available. Canadian Black Book has not seen that in recent months; however, it was common in April and May when there was greater uncertainty in the market.

CURRENT WHOLESALE PRICE TRENDS

Market Level View

Price stability continued for the Car segments last week. Volume-weighted, overall Car segment values increased by 0.10% this past week for all 2012 to 2018 model year vehicles. This minor  increase is similar to the small amount of change we have had over the past two weeks. The previous week showed a 0.03% decline, while  the first week of July posted a marginal 0.02% rise. Of the nine car segments, five increased and four contracted.  . The steepest drops were from Luxury Cars at -0.23% and a small weakening of 0.08% from the Prestige Luxury Car segment. The largest gains were seen in the Full-Size Car segment at 0.64% followed by the seasonally popular Sporty Car segment at 0.49%. These small adjustments confirm the market has paused its sharp decline for the fourth week in a row.

When volume-weighting is applied, overall Truck segments (including pickups, SUVs, and vans) ended the week with a 0.14% decline in wholesale values. Last week’s results continued the recent trend of small declines after the first week of July saw a remarkable 0.18% increase for the Truck segments on average. Of the thirteen Truck/SUV/Van/Crossover segments, only two were up last week as the balance of segments saw declines.

The strongest performers for the week of July 14th were Compact Crossover/SUVs, which were up by 0.30%, and Sub-Compact Crossovers, which were up by 0.29%. The rest of the eleven segments did not perform as well. The largest decliner were Minivans at -0.51%. They were closely followed by Sub-Compact Luxury Crossovers/SUVs at -0.48%

We believe that values for Trucks/Crossover/SUVs will fall by a total of 18% and Cars by 15% during the COVID-19 crisis. At this point, values have fallen by 7.18% across all segments. Given Canadian Black Book’s overall market prediction, this suggests that we are at the halfway point in declines, before values begin a longer term strengthening later this year and early in 2021. We believe this movement in price will be driven by rising demand and falling supply as the Canadian economy begins to recover fully.

The graph provided below (Canada – Weighted % Change in Value by Segment for 2- to 8-year-old models) illustrates 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 four weeks clearly illustrate a major shift in value trending, as shown in the graph. From March until four weeks ago, declines on a weekly basis were much steeper than normally expected. This reflects downward pressure on prices during the pandemic. It is our opinion that recent strengthening in values is temporary, until such time that levels of supply in the wholesale market grow.

Segment Highlight – Small Pickup

As we have written about previously in our weekly report, pickup trucks are a very large portion of the supply of new, and consequently used, vehicles sold here in Canada. Every year, about one in five vehicles that crosses the curb at retail is a pickup truck. How many are purchased by those who need one for work, or the necessities of daily life, versus how many are by people who just desire to own one is an interesting question. In 2019, almost 400,000 vehicles with utilitarian beds in the back were sold. The smaller pick-ups, which were once an overlooked segment, have grown 85% in the last seven years. Even with the recent positive trend, the Small Pickup Truck segment makes up only about 2% of the industry’s new car sales, as compared to 18% for Full-Size Trucks.

There has been a great deal of recent product launch activity in the small truck world, which helps to explain some recent growth and illustrates the perceived future potential. For the 2019 model year, Ford brought back the venerable Ranger name with an all new truck that offered a great deal of utility and a full suite of big truck features, all in a smaller package. For 2021, General Motors has also updated the Canyon/Colorado products significantly. It is expected that Nissan will shortly launch a replacement for the Frontier, which has been around since the 2005 model year. Jeep jumped back into the pick-up truck business and launched a very well received Wrangler-based Gladiator truck. If that wasn’t enough, there are rumors in the automotive media about Ram getting back into the segment with a smaller product offering to replace the Dakota, which was retired in 2011. Prototypes of a unibody truck from Hyundai have also been spotted, yet actual news around what the product is and when it will launch remain secret. Many new entries result in more competition and the segment will likely continue to grow. The expectation is that it will pull consumers from cars and SUVs and perhaps from larger trucks. One of the challenges for the segment has been that the monthly payment difference between larger and smaller trucks can often be quite slim, causing consumers to opt for the larger option when it comes time to make a purchase decision.

In our June Value Retention Index published last week for the Small Pickup Truck segment, it remained almost unchanged, with only a 0.01 Index point decline. Since the COVID-19 crisis began, the segment has only declined by 3.03 Index points or 2.56%. This has significantly outperformed the market average of a 7.18% decline, or 7.77 Index points.

The best vehicle at retaining its value in this segment is the Toyota Tacoma. Last year, the Tacoma took the top honours in Canadian Black Book’s Best Retained Value Awards, for the ninth year in a row. After four years of ownership a Tacoma in average condition is maintaining 77% of its original price. That is not a forecasted number, but the actual result of real-world depreciation after four years. The Tacoma was followed by the Chevrolet Colorado and the Nissan Frontier in third place. The Toyota Tacoma has a well-deserved reputation for reliability and durability in the small truck space that is second to none. As a used vehicle, consumers feel confident that buying one is a wise decision. This makes them exceptionally rare in the market and keeps the prices exceptionally high even for higher mileage and older model years.

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 (Fall/Winter 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 fall/winter, 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.

RETAIL ENVIRONMENT

Retail Prices

Retail asking prices have started to show a small amount of weakness. From early June to last week, the average listing price on retailer lots across Canada has fallen by 1.8%. This analysis is based on CBB’s daily review of vehicles listed for sale by retailers in Canada. Asking prices do not necessarily relate directly to the final transaction price, as retailers do have flexibility on each deal. We have seen used prices fall by 7.18% since the crisis began, a trend that has yet to be reflected in asking prices. The country is currently in a severe recession, so we do expect lower asking prices in the coming months as consumer demand falls.

Retail Insights

• Coming off a healthier June which 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, which will provide some clarity as to what the sales pace will be for the remainder of 2020.
• More than halfway through 2020, 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 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 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.

Repossessions

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.