Collapsing Inventory to Sales Ratio: Auto industry driving the trend off a cliff
U.S. retail inventory to sales ratio at record lows with persistent shortages and no recovery in sight
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You’ve heard it ad nauseam in the news. Shortages, wait lists, out of stock notices, on and on everyday goods are harder to come by. Services are curtailed. Substitutions and adjustments made on the fly. Life is definitely more inconvenient for the consumer.
Perhaps you also read about the port situation where the trade deficit is exploding. The ballooning imports due to regular stimulus checks are creating backlogs of container ships stalled off the West Coast. Through all of this, it is actually surprising to read in the data business inventories remain resilient.
When reviewing retail data, it’s a bit of a different story. While not spared by trade disruptions with order backlogs retail, too, has seem some recovery. There’s a glaring storm cloud on the horizon, however, and that’s captured within the overall inventory to sales ratio. We’ll dive into that below.
Inventory to Sales Ratio Explained
The inventory to sales ratio looks to compare month-end inventory, or stock of goods, with monthly sales. At a national level, it can be useful to spot economic contractions or recoveries. The general ratio over time is for a steady decline. This is due to efficiencies in inventory management across the economy where businesses don’t tie up cash in goods for longer than necessary. “Just-in-time” was the mantra for many companies looking to optimize operations and cash flows. COVID has changed this paradigm.
During recessions, the inventory to sales ratio spikes. This is due to unanticipated demand shocks or contraction in the economy. The collective enterprises tend to operate under Newton’s First Law of Motion: What is in motion stays in motion until something else happens. A sudden reduction in demand takes time to catch up and reduce supply accordingly. As a result, we see a surge in the inventory to sales ratio as the denominator (sales) plunges while supply numerator (inventory) stays constant. It’s akin to Wile E Coyote walking off the edge of a cliff and continues to levitate until he looks down and realizes the ground underneath is now just air. Only then does he fall. Likewise, supply continues flowing in until it realizes demand has dropped off-but there is a lag.
We saw this in the early days of COVID. You heard of cross country flights for $4 as passenger count collapsed. The routes airlines had planned months prior were still in place as demand evaporated. Anecdotally for me, local restaurants were frantically selling off dinner packages over 50% off for pickup as they scrambled to turn inventory into cash. As these phenomena work through the system, eventually supply catches up and is reduced accordingly.
What typically doesn’t occur is for the inventory to sales ratio to fall without stabilizing and recovering. The ratio for decades is bounded between 1.4–1.6 months worth of goods on hand relative to sales. Today, as of September 2021 data, we are at 1.09 months. This is due to rampant shortages of supplies, specifically cars and car parts.
Automotive Market’s Chronic Shortages
Automobiles and parts in 2020 consisted of 31% of retail inventories. For 2021, that number has dropped to 24.4%. Autos and parts have declined -20.9% in year-over-year inventories for September 2021. Overall sales have increased +8.8% since last year despite shortages; however, this is without adjusting for inflation within the sector. Comparing August to September, inventory continues to deteriorate down -2.9% while sales climbed 1.2% month-to-month. 1
Lower inventories are putting downward pressure on the sector’s inventory to sales ratio. Traditionally, the automotive industry operates with an average annual ratio around 2.0. As you can see in the chart below since the start of 2021, this number is hovering stubbornly around 1.0 month’s worth of inventory. The trend has flatlined with no immediate prospects of recovering. In fact, we can count on this to persistently continue.
Today’s vehicles are loaded with thousands of parts, components, and computer chips owing to the hyper-complexity of modern life. Factory automotive production serves as good barometers for the overall health of supply chains as a result. Lower vehicle inventories are buoying the general car, truck, and SUV markets. Toyota minted a healthy profit in their most recent quarter and announced a $1.3 billion share buyback program. At the same time, Toyota announced production would be cut by an astounding 40% in September. Lack of wire harnesses from Vietnam and microchips from Malaysia are cited as prevailing culprits. 2
These effects are being felt across the automotive sector. Repair shops are experiencing difficulty sourcing parts leading to multi-month project delays. Minor inexpensive parts on backorder are impeding these businesses’ abilities to complete their jobs.
“Mirrors, fenders, bumpers, suspensions, doors, quarter panels, glass, the list goes on.”
— Gerald McNee, Owner of Ultimate Collision in Edison, New York. 3
This is also changing business behaviors. Some shop owners are admitting they are hoarding product when it comes available. The natural reaction is to stock up for fear you don’t know when the next shipment comes in. This creates a disjointed allocation of market supply, creating surpluses in certain markets while aggravating shortages in others.
“Oil filters are becoming harder to get, so when I buy them, I buy them in as big of quantities I can get.” 4
- Danny Tomasian River Road Auto Service, Bethesda, Maryland
As inflation permeates the general markets, I believe this behavior modification will be observed more and more. When higher prices are anticipated in the future, consumers will buy up whatever physical supplies they can find. Not only is it a survival instinct, but it’s a prudent investment alternative. If the price for a good will be 10% higher next year, purchasing it today is equivalent to a 10% return on investment elsewhere. We heard about hoarding during the initial days of COVID where buyer’s remorse became prevalent. Just be smart about consumables you load up on if that’s the route you go.
I would be remiss if not discussing the microchip shortage in more detail. The knee-jerk reactions by car manufacturers was to rationally cut back on vehicle sale forecasts. The next step was for manufacturers to cancel microchip orders. This occurred globally. As stimulus checks percolated throughout consumers’ bank accounts, demand sharply rebounded.
Unfortunately for car manufacturers, the chip producers moved on to other customers. The consequences have created logjams netting unproduced and unfinished vehicles. General Motors declared they are removing heated seats from many of their crossover and pickup models. 5 Foregoing luxury features will be the trend going forward. Sadly, the price tags are not reflecting this for buyers with MSRP-or-higher becoming also standard.
The shortages are impacting auto exporting markets especially hard. Countries such as Japan, home to a number of major manufacturers, noted the general parts shortages caused exports to collapse -46% year-over-year in September 2021. 6
Relief doesn’t appear anywhere on the horizon. It’s been almost two years since the start of the COVID crisis, and auto sector shortages are at their worst currently. Anecdotal conversations with local dealers in my area note similar experiences. Not only is the car inventory excessively low, but service departments are noting multi-week delays for parts. Some don’t even display a date of availability.
Looking ahead at the inflationary environment we’re sleepwalking into, there are actions to take avoiding being stranded with the herd. If you’re thinking about doing something, do it. If there’s a lingering repair needed, fix it. If there’s an appliance to replace, buy it. If you can stock up on nonperishable items, do it. The lesson learned through these supply chain crises is to have resiliency. As the economies rebalance and businesses reevaluate their sourcing, now would be a prudent time to take action. Be smart with those choices. Be intentional.
Originally published at https://powerandmarkets.substack.com on November 29, 2021.
