Perhaps we spent too much money buying and destroying perfectly good “clunker” cars. Amazingly, despite all the economic indicators to the contrary, the market for used cars in America is booming. Last week, the Manheim Used Vehicle Value Index hit 121, an all-time high.
“We can trace the strength in the Manheim Index back to the ‘cash for clunkers’ giveaway,” writes Dan Amoss. “The government’s destruction of the used car supply has boosted prices temporarily. But the other factor in used car pricing -- demand -- will remain weak as the U.S. population of registered autos stagnates or shrinks.
“Upticks in the Manheim Index can boost reported earnings for car rental companies. Strength in used vehicle prices will boost one-time gains from selling depreciated cars out of the fleet. This happens because a rental company buys a new car, books depreciation charges against it as it is rented out, and then sells it (hopefully) above its book value a few years later.
“But this effect is only temporary; it will reverse once the index turns back down. Its effect on earnings should be viewed as a ‘one-time’ item.
“If rental car companies want to maintain earnings power, they must reinvest the sale proceeds from old cars into a new car. This negates the fantasy that car rental companies ever generate consistent free cash flow. They can generate free cash flow when they’re aggressively shrinking fleets, but in that scenario, these stocks would deserve very, very low earnings multiples.”
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