Are luxury cars recession-proof? Stephen Wilmot examines luxury vehicle makers and their resilience in The Wall Street Journal, writing:
Luxury car brands should be better long-term investments than mass-market ones. That doesn’t mean they are recession-proof.
Less than two weeks after its initial public offering, Porsche POAHY -4.42%▼ has already overtaken its majority shareholder Volkswagen VOW -3.29%▼ in terms of market value. The comparison is simplistic, given differences in capital structure, but it does underline, among other things, investors’ preference for expensive vehicles over cheaper ones as the risk of weakening demand becomes harder to ignore. While most auto-maker stocks trade at mid-single-digit multiples, Porsche is now at almost 17 times this year’s earnings, extrapolating from its guidance.
Meanwhile, economic worries are growing louder on both sides of the Atlantic. In Europe, the focus is on energy: Even with massive government support, sky-high power prices are likely to crimp economic activity and consumer spending. In the U.S., the problem for a product typically sold on credit is rising interest rates. Bad quarterly results last month from used-car bellwether CarMax, which warned of a “shift in consumer spending…to smaller discretionary items,” sent shudders through the sector.
On one level it makes sense for investors to take refuge in luxury. Brands such as Porsche or Ferrari allow companies to charge high prices for vehicles that aren’t much more capital intensive to produce than ones that compete to offer value for money. This is why high-end producers screen so much better than mass-market peers on classic metrics of company “quality” such as cash flows and returns on capital.
But this doesn’t mean Porsche isn’t cyclical, far from it. Although it got through the short, strange Covid recession with hardly a scratch, the previous downturn was different: Sales fell 22.5% in 2008. Analysts at Quest, the cash flow specialist division of Canaccord Genuity, point out that Porsche’s 911 sports car fared even worse, with production more than halving over the five years ending in 2011. This is the model that the company sees as the embodiment of its brand—to the point of naming its stock-market ticker P911.
Leasing, which accounted for 43% of cars sold by Porsche last year, could be a vulnerability. Some buyers likely leased for convenience, but others may not have been able to afford the brand without the leasing option, which makes luxury cars more accessible because of their high residual values. Rising interest rates will challenge the financial wizardry behind this ownership model, particularly as secondhand car values fall from their recent highs.
Conversely, a downturn could be less dangerous than feared for mass-market car makers, given the current shortage of vehicles for sale—the result of almost three years of recession-level production numbers. The fat order books they are currently sitting on would shrink, but the combination of weak demand and weak supply could keep prices high. Companies that worked hard to restructure during the good years, such as General Motors and Stellantis, seem better prepared for stormy weather than the market is giving them credit for.
The coming couple of years could put all auto makers’ earnings to the kind of quality test they haven’t had in years—the Covid dip in demand was too short-lived to count. The results may not be quite as clear-cut as investors seem to expect.
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