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Gas prices, loan rates ‘a real problem for auto demand’: Analyst

Bank of America Merrill Lynch Managing Director John Murphy joins Yahoo Finance Live to discuss the outlook for rising interest rates for auto loans, rising gas prices, EVs, market headwinds, affordability risks, and the impact for the auto market.

Video Transcript

JULIE HYMAN: Let's talk more about the auto industry specifically. Rising rates are putting affordability at risk for people who are looking at those high gas prices. They have this to contend with as well. In a recent note, our next guest said, should rates continue to rise, consumers will likely face an increase in monthly payments, of course, which could pose concerns for vehicle affordability and sales. For more on this, let's welcome in Bank of America Securities senior autos analyst, John Murphy, as well as Yahoo Finance's Pras Subramanian, who's here with us on set.

John, thanks for being here. So you have, effectively, what we're seeing start to happen in the housing market, also a potential risk in the car market, right, where you are seeing financing costs go higher. But conversely, does that mean we're finally going to get a little bit more relief on the pricing front for cars?

JOHN MURPHY: Sure, well, Julie, thanks so much for having me today. There's a lot of moving parts, I think, as you just alluded to with gas prices rising as well. And I think when you look every 100 basis point increase in auto loan rates, it's about $15 to $20 on a basis of about $600 on monthly payments. So what we've seen is about that so far in a 48-month average rate. Auto loan rates have not been as volatile as mortgage rates, so we're getting sort of an impact that is not as big.

But as you look at this versus gas prices and depreciation costs, you're kind of at a push on the monthly carrying cost to the consumer when you include depreciation costs. Now that means you're selling your vehicle, and you're getting the benefit of lower depreciation. So there's a lot of moving parts here. But all else equal, these rising rates and these rising gas prices are a real problem for auto demand. The caveat really to all of this is, there just aren't enough vehicles on dealer lots and one or three-year-old vehicles on the road in the United States.

So we are building a lot of pent-up demand. And the consumers that are buying nearly new used vehicles and new vehicles as well are fairly well-heeled higher income consumers that will be less impacted from this. So where we are-- from where we're starting right now at recession level auto volumes, because supply is so constrained, we don't have a lot of concern about too much downside to demand. But it could really dent any significant recovery in the next one to two years.

PRAS SUBRAMANIAN: Hey, John, Pras here. You guys had a lot of good information in your note about the level at which we've seen situations where high rates haven't actually led to decreased sales in autos. But is there a point where there is a rate that would actually destroy kind of demand for new cars, or even used cars, at that-- at those-- with rates as they are now?

JOHN MURPHY: Sure, you know, it's a really great question. So if we look at the 100 basis point rise in rates, it's about $15 to $20 a month on the monthly payment. We've seen what's going on with gas prices. It's about each dollar increase is-- or actually, the $2 increase is almost about $40 to $60 a month on each individual vehicle. But then when you look at depreciation costs being lower, because used vehicle pricing is higher, you have about $100 good guy.

So the net of these three big moving parts of rates, gas prices, and depreciation costs are not too tough for that new vehicle buyer. Once you get to the second and third buyer, that's where things get into the middle and lower income consumer, and things get tough. So I think we're looking at sort of the balance of these three big swing factors right now. And the strength in used vehicle pricing is a very important and actually bigger factor, believe it or not, than what's going on with rates and gas prices.

As we increase the supply of vehicles that are being produced, there's risk that that depreciation will go up, cost, and we can see things really keep a lid on what we expect to be a significant recovery. So we've got to watch all three of these factors, swing factors, moving at the same time. So the interest rates are actually less important, believe it or not, at the moment than gas prices and that depreciation cost.

BRIAN SOZZI: John, we've seen a massive push by the major automakers into crossovers and trucks, but that has come against the backdrop of relatively affordable gas prices. That's no longer the case. Do you think we'll see them swing back to making passenger cars because of this environment we're in?

JOHN MURPHY: Well, there's a lot of different strategies in the market right now, where the D3, or the traditional D3, have moved away from passenger cars. And the Japanese and Koreans have still kept a reasonably large portfolio there. So that's where the benefit would come, more in the Japanese and Korean side, if we see this kind of a move. Because we're selling so low in sort of the sales rate recession levels because we're supply constrained, the mix is going to stay very strong until we actually see supply coming back up and actually get a sort of, vehicles available for sale, right? Because they're just not there at the moment.

So I do think in the recovery, you could probably look at a greater mix of passenger cars and smaller crossovers. Remember, these crossovers are unibody, essentially jacked up stationwagons, if you will. They're not the body on frame gas guzzlers. They're relatively fuel efficient themselves. But you'll still see a negative mixed shift as we go through the recovery.

So that would benefit the Japanese and Korean companies a bit more than the D3. So that would dent industry profitability relative to the recovery in volumes. So, once again, we'll have to watch operating leverage versus mix. And that'll be a delicate or interesting dance when we look at profitability through the value chain.

JULIE HYMAN: Hey, John, on a related note, when you look at the affordably priced hybrid and electric vehicles that are out there, I mean, it doesn't seem like there would be enough to meet demand, if there is, indeed, increased demand with higher gasoline prices, right?

JOHN MURPHY: Yeah, there's another-- it's a very good question, Julie. There's another very difficult dance here right now with that. And when you look at the increase in nickel, cobalt, lithium prices, the cost of these electric vehicles has gone up much more dramatically than even the internal combustion engine vehicles. So, unless the industry wants to eat an incremental $1,000 of cost on an EV versus an ICE, they're not going to push the EVs as aggressively here in the near term.

And if they do try to pass that cost onto the consumer, the consumer then has to eat another $1,000 plus for the payment or the price of these EVs. So that switch, which if you were just to look at gas versus electricity cost, makes all the sense in the world. But when you look at the asset price coming in, it becomes a lot less clear and actually becomes a net negative for EVs versus ICE on affordability in the near term.

So there's, like I said, there's a lot of moving parts of what's going on here right now. But that raw mat swing on EV costs has been pretty extreme in the last six months, even more extreme than what we've seen in gas prices or steel costs going into the cost of ownership on an ICE vehicle.

PRAS SUBRAMANIAN: Hey, John, given all those moving parts and the rising rates and things of that nature, as well as the kind of diminished supply, in your coverage universe, what auto companies or what suppliers are really well positioned here to do well going forward in the next year or two?

JOHN MURPHY: When we look at-- and we cover that in the value chain. So we cover the automakers, suppliers, and dealers. And what's happened in the course of the last two years is the automakers and dealers have benefited tremendously from the improvement of mix in price. So they've been able to more than offset the volume pressure. So it's been pretty impressive and as well as very good execution.

The suppliers have not benefited from any real pricing power because their end consumer is the automakers. They're not really changing pricing on a real-time basis. So they've been really getting hit in a way that the dealers and the automakers have not by just the pure volume decline. They're just eating it pretty hard on this volume decline. So I think as we look forward on a relative basis, the suppliers are likely to do a lot better if the semiconductor chip shortage issue works out and other supply chain constraints get worked out, and we see a real volume lift.

I think the automakers and dealers will also do fairly well. But on relative to expectations and where people are thinking about how they're thinking about these stocks and the different links in the value chain, the suppliers are the most depressed and have been hit the hardest fundamentally because they haven't had the benefit of pricing power at the consumer level.

BRAD SMITH: John, at this point in time, is it more beneficial for a potential buyer, prospective buyer, to get a used car or a new car? That's all they're thinking about right now.

JOHN MURPHY: You know, we got a lot of moving parts here. When you look at this, the relative price of a 3 and 1/2 year old vehicle-- and some of these stats are coming from our great friends at Manheim and other used car sources-- you basically are looking at 10 to 15 points above normal on a used vehicle price relative to a new. So normal on a 3 and 1/2 year old vehicle would be around 50% to 55% used vehicle price to new vehicle price. Right now, it's in the high 60s, close to 70%. So relative to the history, the value buy was always to go to the used vehicle.

You know, right now, if you have a vehicle to trade in, you may actually be better off buying a new vehicle if you can actually find it, right? That's the big catch. Vehicles are really not that plentiful. So if you are lucky enough to own a used vehicle that's inflated in price, as opposed to buying another used vehicle, you're probably better off stepping into buying a new vehicle at the moment.