- The semiconductor shortage, in partnership with high inflation and rising interest rates, will continue to restrict passenger car sales in Canada.
- Record vehicle prices, pushed up by the supply-side shortage and high inflation, will restrict vehicle sales, particularly amongst low and middle-income consumers, as prices are widely unaffordable to consumers.
- The increase to autos loans costs, as a result of rising interest rates, will dampen consumer interest in purchasing a vehicle, posing a downside to sales.
- We expect that the rise in autos loans costs will impact low-income consumers, who rely on autos loans to purchase a vehicle, particularly those in rural areas that rely on a vehicle as the main means of transportation.
We believe that the semiconductor shortage, in partnership with high inflation and rising interest rates, is restricting passenger car (PC) sales in Canada. Reports from local dealerships suggest that the supply-side shortage of vehicles, caused by the chip crisis, continues to limit sales in the market. Indeed, data from DesRosiers Auto Consulting shows that total vehicle sales are down by 16.2% y-o-y this July, and 24.8% down from pre-pandemic (July 2019) figures (see graph below), while sales in H122 are down by 12.5% y-o-y and 23.2% down from pre-pandemic figures.
Vehicle Sales Remain Below Pre Pandemic Levels
Total New Vehicle Sales (2019 - 2022)
As a result, we have made a downward revision to our Canada sales forecast in 2022 and now expect total vehicle sales to contract by 1.1% y-o-y, down from 1.4% growth previously. Data also showcases that sales are adversely lower in the PC segment than the light truck segment; Autocar states that passenger car, SUV and van sales are down by 15.0% y-o-y in Q222, while the pick-up segment expanded by 5.0% to increase its market share to 23.0% in Q222, up from 20.0% in Q122. We believe that the reasoning behind this is threefold; firstly, this contrast is partially due to the lower amount of chips that are generally required in trucks compared to PCs, meaning that there is greater availability of trucks for consumers to purchase. However, we do note that high-tech pickups, such as Ford’s F150, that feature an array of electronic features, have also had their manufacturing targets impacted by the shortage. Secondly, we believe there is greater supply of light trucks as automakers in Canada have prioritised the segment over PCs in order to produce a greater number of vehicles with the limited supply of chips. Thirdly, we have seen consumer demand for light trucks outweigh the PC segment for some time, and we expect this segment to be bolstered across our forecast period to 2031 (see graph below) by the launch of electric models that are set to capitalise on this consumer preference and positive support for EVs in a number of provinces. The retooling of Ford, Stellantis and General Motor's plants to produce EVs in 2022 is testament to this trend. Consequently, we have altered our forecast to reflect these dynamics; we now expect PC sales to contract by 15.0% y-o-y, down from a contraction of 5.4% previously, and that the light truck segment will grow by 2.0%, down from 2.8% growth previously.
Car Share To Keep Shrinking
Canada - Light Vehicle Sales By Segment (2014-2026)
We believe that high inflation and rising interest rates are also depressing consumer interest in purchasing a vehicle. We note that high inflation, and the supply side shortage of vehicles, has pushed up vehicle prices to a range that is widely unaffordable to low and middle-income consumers. Recent data from Autotrader shows that the average price of a new vehicle rose to CAD54,048 in May, a 17.3% y-o-y increase and a 1.0% rise from April, when prices last hit a record high. Used vehicle prices also increased in May, reaching an average price of CAD37,984, up 36.4% from 2021 and nearly 1% from the previous month. Used vehicle prices also remain at a 32.0% increase y-o-y in July 2022 at an average of CAD37,928. Although, we do note that the price dropped by 0.6% from June 2022, suggesting that prices have peaked. Our Country Risk team believe that inflation will remain elevated into 2023, averaging 4.6% y-o-y, before dropping to 2.2% in 2024. Consequently, we are bearish on sales across all segments throughout Q422 and into H123, particularly given that we do not expect the chip shortage to abate until mid-2023 onwards, meaning that a supply-side shortage of vehicles will persist until that period.
Moreover, rising interest rates (see graph below) have led to a surge in borrowing costs, making it more expensive for consumers to use autos loans as a method to purchase a vehicle. Our Country Risk team upwardly revised its end-2022 benchmark interest rate forecast for Canada to 3.75%, from 2.00% previously, underpinned by its expectations for sharply higher global commodity prices – pushing up inflation. Mounting price pressures have already prompted policymakers to raise the benchmark interest rate by a cumulative 225 basis points (bps) since the start of 2022. The team expects the Bank of Canada to raise interest rates at both the September and October monetary policy meetings. At the September event, the team anticipates that there will be a 75bps interest rate hike. This will precede another 50bps increase in the following month, leaving the benchmark rate at 3.75% at the end of 2022.Tighter monetary policy is likely to reverse the recent acceleration in household credit growth – which also hit 8.1% y-o-y in May 2022 – adding another headwind to consumer spending and vehicle sales.
This rise in interest rates has also translated into higher costs for autos loans and autos financing schemes in the market, posing a downside risks to sales, particularly to consumers from low-income backgrounds that rely on autos loans. We expect that the increase in the rates of autos loans is placing increased pressure on consumers to cover loan costs, which will dampen consumer confidence in purchasing a vehicle using this financing method until interest rates have been lowered, which our Country Risk team expects to occur in 2023 with a reduction to 3.0%.
Moreover, we highlight a broader trend in autos loans financing in Canada that we believe poses a long-term risk to vehicle sales in the market. Data from JD Power notes that three quarters of financing of new vehicles in Canada uses terms longer than five years, noting that seven-year loans make up 40.0% of financing. JD Power notes that these extended term loans have become increasingly common over the past decade, with a seven-year loan now being the most common term length for used-vehicle loans in the market (see graph below).
Auto Loans Beyond Five Years Now The Trend In Canada
Canada - Percentage Of New Vehicle Auto Loans, By Term Length (2021)
In the current period of high interest rates, this means that consumers are paying more for a vehicle over a longer time period. We believe that this poses downside risks to sales over the longer term (2022-2025), as extended-term loans come with a higher likelihood of consumers carrying negative equity, whereby consumers can potentially become indebted to the dealership if the value of a vehicle falls below the outstanding amount of the loan secured on it. This is particularly likely in the first three years of vehicle ownership, as new vehicles lose around a third of the original value within the first 12 months of ownership. Consequently, we note that there is a greater risk of consumers not being able to service their debt over the next two-year period, particularly if they are unable to pay the higher rates. We believe that this will disproportionately impact low income consumers, particularly those with higher autos loans rates due to low credit scores, and particularly those that live in rural areas that rely on a car for transport. Although concern surrounding the commonality of extended-term loans and the subsequent rise in autos-related debt has prompted some Canadian regulators to improve regulatory practice on autos loans, currently, only British Columbia, Alberta, Manitoba and Quebec have legislation concerning high-cost loans, meaning that there continues to be a lack of regulation surrounding how lenders provide autos loans. Consequently, we note that, until solutions are provided to tackle these regulatory gaps, there will continue to be heightened risk surrounding the provision of extended-term autos loans to consumers in the market, particularly low-income consumers being offered higher rates.
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