Like many commuters, my partner and I have a “station” car. In our case it’s my partner’s beloved 10-year-old red Mini Cooper. Tracey, my partner, loves it – I hate it.
It’s heavy on the steering, the air-con doesn’t work and it’s continuously tuned to Vanessa Feltz in the morning. Warning lights flash off and on with a regularity bordering on disturbing. Lately, we have been umming and ahhing about replacing it for a new station car.
Despite my hatred for this abomination of an automobile, I am reluctant to replace it just yet. Why?
Being a multi-asset manager, I like to buy things when a brand or industry becomes so toxic that people are desperate to sell anything linked to it, regardless of quality. I love bargains, and that situation is like a repo auction in heaven. And I think I can smell one coming.
You see, I own a new Audi TT (third mid-life crisis) which I purchased, like most people these days, via a Purchase Contract Agreement (PCP) – secured credit by another name. PCPs let you lease a car for much cheaper monthly payments than if you borrowed to buy it outright. At the end of the term, usually three years, you have the right to buy the car using a balloon payment at a pre-agreed price (the sticker price less depreciation) or you can just walk away.
Now, these deals are designed to encourage punters to trade in (trade up) their car. Car manufacturers have an obvious incentive to lock customers into buying the next model to roll out of their factories. They do this by setting depreciation at a slightly more aggressive level than the market. That way, when you come to the end of the term the car is worth slightly more than the balloon payment. Now you have “equity” on the table that you can put towards a deposit on your next set of wheels. If you walk away, however, you lose that “equity”.
Many people have seen this as a great deal. Increasingly, this is the go-to transaction for funding new car purchases. In 2015/16, 76% of all new UK private car sales used PCP finance, according to information services group Experian. Between 2009 and 2016, total household auto debt almost trebled to more than £30bn. And the car companies make good money so long as that residual value of the traded-in cars is in positive “equity”. Or, put another way, if the value of the car on their books is below that of the prevailing second-hand market price.
But what happens if there is a glut of used cars during a recession or when consumers are feeling more subdued? In the five years to 2016, the value of used cars on sales forecourts jumped 46% to £23.4bn. What if more people decide to hand the keys back rather than pay the balloon payment or trade in for a new car? Prices will fall and auto finance companies have suddenly got loans secured on assets worth less than the value of the loans. Sound like sub-prime property to anybody?
The result would be a fire-sale of used cars. Yes please, I will be a buyer.
This scenario is not extreme. I have not even thought about second-hand values for diesel-powered cars as taxes rise or, indeed, petrol-powered vehicles as electric becomes mainstream. These issues have huge ramifications for the share prices of companies throughout the automotive value chain, as well as the bond prices for those companies exposed to the financing of PCP agreements.
The auto industry is obviously going through a huge transformation, driven by political and technological factors, over and above the normal cyclicality of demand. Any exposure needs to be judicious. We are looking to invest in the beneficiaries of these structural changes and avoiding those that appear slow to adapt.
Caution is needed even in the exciting new areas as hype is always evident.
For now, I am still driving the Mini, but I may be rocking up to an Arthur Daley forecourt relatively soon to buy a low-mileage star-buy of the week. If it’s down to me, it won’t be a Mini. So it will be!