Re-tapping the car markets potential

Total car sales during the first quarter of 2009 were down 40% from a year earlier, representing a difficult time for anyone trying to make a living in the automotive industry.  But the question on many people’s minds is whether car sales will regain their former glory once the economy improves.  This article provides five-year estimates for the three drivers of car sales – replacement demand, ownership rate, and household formation.  Car sales appear to be well below fundamentals at present, and are poised to rise significantly when the economy improves.

Sources of demand for new cars

Underlying demand for cars comes from three main sources: replacement demand as older cars depreciate, growth in the number of households in New Zealand, and growth in the number of cars per household.  Changes in these variables can have long-term effects on the demand for cars.

Shocks to the economy like the 2008/09 credit crisis have immediate and noticeable effects on sales. But sales rebound after temporary shocks.  The extent to which they rebound is dependent on the longer-term factors just mentioned.

Replacement demand

The availability of lower-cost used imports has led to a high rate of turnover in the New Zealand car fleet over the last few years.  During the five years to 2008, 40% of the car fleet was consigned to the scrap heap or sold offshore.  Replacement demand was the largest component of imported car sales during this period. 

During the March 2003 quarter, 80% of first-time registrations were used imports.  By March 2008, this figure had fallen to 61%, and the ratio has continued to decline throughout 2009.  So is the rapid decline in the popularity of used imports temporary or permanent? 

Progressively tighter regulations have put the brakes on older, dirtier used cars being bought into New Zealand, closing the average price gap between new and used cars.  Furthermore, reports suggest that used imports from Japan have become harder to secure in recent years due to increased demand from other left-hand-driving countries.  This increased competition is likely to become an issue again as the global economy picks up over the next 2-3 years.  These factors suggest that used car sales won’t regain their previous share of total car sales when the economy recovers.

But we do expect to see some rebound in sales of used imports over the next five years.  Even though the price gap has closed, imported used cars remain a lower-cost option for households.  In recent years used car sales have been crowded out to an extent by sales of second-hand New Zealand new cars through ex-lease sales or Trade Me auctions.  But due to low numbers of new car sales at present, the supply of second-hand cars will struggle to keep up with demand in 3-5 years’ time.  This shortage will boost car resale values and create an opportunity for used car importers to lift sales.

Because the existing car fleet is aging all the time, the process of cars depreciating and eventually being scrapped creates demand for both newer and older cars.  The average age of cars being scrapped in New Zealand is about 17, and has remained more or less the same over the last five years.

Graph 1.1 shows the distribution of cars in the 2007 fleet by year of manufacture.  The spike in used imports which were manufactured around 1996 can be attributed to the change in frontal impact standards, introduced in 2001.  In 2007 the average age of used imports entering the New Zealand car fleet was 8.2 years, 3.8 years younger than the average age of the existing fleet.


Graph 1.1

In 2007, 66% of New Zealand’s car fleet was manufactured between 1990 and 2000.  There are over 630,000 cars on New Zealand roads that are between 16 and 30 years old and, as they continue to age over the next 5-10 years, upward pressure will build on car sales.

For the purposes of this analysis, turnover rate is defined as the number of cars being scrapped each year as a percentage of the existing car fleet.  The turnover rate has been strongly correlated with used import sales over the last ten years.  The turnover rate averaged 6.8% between 1998 and 2008 and exceeded 7%pa for eight out of the last nine years.  Over the next five years it is likely that turnover will continue to average around 6.8% or higher, due to the middle-heavy age distribution caused by the glut of used imports.  All things considered, a turnover rate of 6.8% for the next five years can be considered a fairly conservative estimate.

Assuming a turnover rate of 6.8%pa, replacement demand would equate to average sales of just over 155,500pa over the next five years assuming the total size of the car fleet doesn’t change.   But the size of the car fleet will change, which is why estimating the ownership rate and household formation is also important.

Ownership rate

New Zealand’s car ownership rate has been steady at 1.42 cars per household since 2005, up from 1.36 in 2003.  The decreasing cost of cars appears to have driven a lift in the ownership rate prior to 2005.

It is unlikely that we will see a further increase in the ownership rate over the next five years.  The cost of running a car has increased substantially since ownership rates levelled off in 2005.  There have been increases in registration fees, Acc levies, and of course the cost of petrol.  Increased environmental awareness and substantial investment in public transport in some regions also work against high car ownership rates.  However, we should see new car prices ease over 2010 as the exchange rate strengthens and the cost of a new car is expected to continue to trend downwards in real terms over the next few years. 

For the purpose of estimating underlying demand for new cars, we assume the ownership rate will ease slightly to an average of 1.40 cars per household over the next five years.

Household formation

Household formation remains strong, which means the New Zealand car fleet will expand significantly over the next few years even if ownership rates fall slightly.  An easing in the ownership rate to average 1.40 cars per household over the next five years would see existing households shed over 30,000 cars during this period.  But for every 100 new households formed, 140 extra cars will enter the New Zealand fleet. 

Over the five years to March 2008, the total number of households in New Zealand expanded by 8.3%, and we forecast the number of households to expand by 7.4% over the five years to 2013.  This forecast takes account of the current age distribution of the New Zealand population, and expected future migration.  These extra households will require an estimated 160,100 new vehicles between 2008 and 2013, an average of 32,000 additional cars per year. 

Crunching the numbers

Coming up with an estimate of underlying demand for cars isn’t simply a case of adding together the three components.  Firstly we combine our assumptions of an ownership rate of 1.4 cars per household and household formation of 7.4%pa.  Under the scenario the size of the New Zealand car fleet would expand by a net 26,000 each year on average.  The demand from new households more than offsets the expected easing in ownership rates. 

Bringing in our assumption of replacement demand of 6.8%pa, we would expect underlying demand to average 188,100pa over the next five years.  Given that total first-time registrations fell below 127,600pa in August 2009, significant upward pressure will build on sales as the economy improves.

The main risk to this estimate is the possibility of a sharper fall in the ownership rate.  Sensitivity analysis shows that a drop in the car ownership rate back to the 2003 level of 1.36 cars per household would see the fleet expand by 46,900 cars over the five years to 2013, an average of 9,400 annually.  This would see total car sales average 171,500 over the next five years – still significantly above the current level of sales.  Because this would require a sharp drop in ownership rates, it seems sensible to take this as the worst case scenario.

Summary

Taking conservative estimates of replacement demand and demand from household growth, we estimate that the underlying demand for cars over the next five years will be at least 188,100pa.  This compares to average annual sales of 210,600 over the last five years.  But the composition of sales is changing, and we expect to see new cars make up a greater proportion of total first-time registrations over the next five years compared to the previous five years.  This shift will start to correct the age imbalance, which is a legacy of cheap, easy-to-obtain used imports earlier this decade.

With sales currently at about 127.600pa due to the domestic economic downturn activity will have to rise significantly to meet underlying demand.  The longer that car sales stay below our estimated trend rate of 188,100pa, the further they are likely to rise when the upturn arrives.

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