Weekly Reads - May 15, 2023
Please read the Unison Asset Management Social Media Disclaimerhere
The continual rise in the average age of U.S. vehicles is a durable tailwind for aftermarket part retailers who provide immense value to consumers who are looking to extend the life of their vehicle in the face of unaffordable new vehicle prices.
There are over 284 million vehicles on U.S. roads with the average age of these vehicles rising to a record 12.5 years in 2022. This is the sixth straight year of increases which has been caused by a mix of constrained new vehicle inventory during COVID and slowing demand due to rising inflation and interest rates. While there remains optimism that in 2024 we will see the average age of U.S. vehicles flatten the macro environment remains in flux and new vehicles continue to become pricier. The growing popularity of electric vehicles and the adoption of safety/entertainment technology continue to push price tags for new vehicles higher. Automakers are looking to expand their margins and revenue per vehicle by pushing subscription services and offering more premium services. These initiatives might help automakers grow their top and bottom lines, but they continue to push consumers to buy used cars or extend the life of their existing vehicles. S&P Mobility predicts that by 2028 the volume of vehicles aged 6-14 years will grow by another 10 million units. This age group is the “sweet spot” for aftermarket repair in which vehicles need the most repair and maintenance as original parts start to fail. This trend benefits aftermarket parts retailers like O’Reilly and AutoZone who supply most of these replacement parts to do-it-yourself car owners and professional mechanics across the U.S. These aftermarket companies have a long runaway to support the aging vehicle base in the U.S. while expanding their product line to include EVs and replacement parts for newer vehicle models.
Automakers promise of recurring revenues, expanding margins, and stronger topline revenue might be in jeopardy as consumers are pushing back against “vehicle-as-a-service”.
The growing popularity of EVs and the onset of vehicle subscription services have automakers salivating about the potential margins they can eventually generate from each sale. Tesla, who popularized the idea of selling subscription services in their vehicles, is seen as the model to follow for traditional automakers who want to expand margins and reduce revenue cyclicality over time. We have already seen automakers like BMW cause a massive stir by introducing subscriptions for traditionally free features like heated seats. BMW is charging $18 a month for access to heated seats for a car that the consumer has already paid thousands of dollars for. The main issue for this subscription is that heated seats are built into every BMW, so the consumer is being forced to pay for the hardware through the sticker price of the car and then having to pay for the service for the life of the vehicle. This is very different from the Tesla subscription model which is software-based (self-driving, entertainment, etc.) allowing the user to pick and choose what features to pay for without having to pay for it through the sticker price. Other companies are dipping their toes in this new market with Mercedes recently offering users the ability to unlock 60 more horsepower for $60 a month. Like BMW, Mercedes is essentially providing a worse driving experience on purpose to incentivize users to pay for the added subscription service despite the car already having the capability to provide the extra horsepower without the subscription. As these subscription services become more popular many consumers are becoming more resistant to the idea of paying for features that were traditionally included in the sticker price. According to a Cox Automotive study, 69% of respondents agreed that if certain features were available only via subscriptions for a particular brand they would shop elsewhere. By putting key features behind a paywall, automakers could be inspiring loyal customers to look at rival brands or even look at used vehicles. It will be interesting to monitor how long it will take to retrain consumers to pay for features that were traditionally free and if any automaker is willing to go against the grain by continuing the traditional vehicle sales model in order to capture market share and win consumer loyalty.
The bankruptcy of seven large companies in the span of just 48 hours shows the dangers of high leverage and the growing inability to raise capital in this market environment.
Seven large companies including digital broadcaster Vice Media and KRR-backed Envision Healthcare Corp have filed for bankruptcy over the last 48 hours. That is the largest number of bankruptcy filings during a two-day period since 2008. These companies struggled with high debt loads and higher interest rates as demand weakened. Vice Media was once a high flyer securing a $450 million investment from TPG valuing the firm at $5.7 billion. The company was forced to sell itself to creditors Fortress Investment Group, Soros Fund Management, and Monroe Capital who paid $225 for the company’s assets. Envision Healthcare, a medical staffing company backed by KRR, struggled to meet its debt obligations in the face of higher interest rates and wage inflation despite raising $1 billion in new cash just last year. These bankruptcies are a good reminder that a strong balance sheet is a key trait for a great business. Access to cheap capital can mask bad business models and fuel destructive M&A that can last years. Once that cheap capital dries up we are left with moments like this in which former market darlings exit and the companies remaining with robust balance sheets capture more of the market.