Macroeconomic Backdrop

As U.S. consumers' excess savings are depleted and unemployment rates rise gradually, we expect limited growth in auto sales through 2026. This is consistent with our expectations at the start of the year. We do not expect auto sales will recover to pre-pandemic levels in our forecasts through 2027.

We forecast global production will remain tightly linked to demand as automakers stay disciplined on inventory build-up, given subdued economic growth expectations. Though the U.S. economy remains more resilient than we had expected so far in 2024, we continue to expect GDP growth will slow to below 2% in 2025 and 2026. This will be accompanied by a further rise in the unemployment rate and lower inflation (see "Economic Outlook U.S. Q4 2024: Growth And Rates Start Shifting To Neutral," published Sept. 24, 2024, on RatingsDirect).

Gradually rising unemployment and the usual delayed impact of tight monetary policy on consumers' purchasing power are key factors in our outlook for U.S auto sales for 2025 and 2026 (see chart 1). This is consistent with our expectations for a more modest recovery of global volumes in 2024-2026 following a stronger-than-expected rebound in 2023 due to the release of pent-up demand amid easing supply chain constraints (see "Global Auto Outlook: More Players, Less Profit," published Oct. 9 on RatingsDirect).

The U.S. auto industry had been operating near recession-level in terms of auto sales for almost three years. In 2023, U.S. auto sales increased 12.4% as supply chain constraints eased, vehicle inventories at dealerships improved relative to mid-2022 levels, and sales to fleets increased significantly.

A recovery over the next two years toward the 30-year historical median of 16 million vehicle sales will depend on further price reductions and declines in interest rates. Our forecasts incorporate narrowing cushions at households to absorb the back-to-back macroeconomic shocks of high vehicle prices, ongoing inflation, and high monthly payments for auto loans and leases.

Demand weakness among retail buyers persists as the share of rental car and commercial fleets will increase and return to pre-pandemic levels this year (roughly 20% of light vehicle sales). The U.S. auto industry will also adjust to a slower growth environment (compared to our January 2024 expectations) for battery electric vehicles and plug-in hybrids in 2025-2026 per slightly revised S&P Global Ratings estimates (see table 1).

Chart 1

Table 1

Lower Ratings Headroom In The U.S. Auto Sector

Though the U.S. will likely avoid a near-term recession and settle into a soft landing, recession risks remain. The recent loosening of the labor market indicates a normalization, as opposed to a U.S. economy that's about to slip into recession. An expansion of the labor force, rather than a fall in employment, has spurred the rise in the unemployment rate up to now--a key difference from previous cycles at the start of a recession.

Still, we expect the unemployment rate will likely rise in the next several quarters--to 4.5% by the end of 2025, from 4.2% currently. In addition, real income growth has softened, and there are signs of slowdown in discretionary consumption. For example, American households (especially in the lower-income bracket) are tapping more into credit, and auto loan delinquencies are rising above pre-pandemic levels and approaching the highest levels seen in over a decade.

We expect labor costs and other inflationary pressures will remain even as production volumes weaken globally this year. As a result, we expect modest credit deterioration in the auto sector, particularly at the lower end of the ratings scale.

Consistent with our macroeconomic forecasts and the Fed's recent communications, we now anticipate the Fed will cut interest rates by an additional 50 basis points (bps) in the fourth quarter of 2024 and by 125 bps in 2025.

For the U.S. auto sector, credit metrics--such as debt to EBITDA and free operating cash flow (FOCF) to debt--will gradually stabilize by year-end 2024. We believe this is because most companies (especially those rated 'BB' or below) will look to preserve liquidity in line with pre-pandemic levels and limit large, debt-financed acquisitions.

So far this year, the steadier supply chain, production discipline at most OEMs, and lower ocean freight rates has resulted in generally improved margins and free cash flow for most suppliers. This has reduced the negative rating bias (percentage of issuers with a negative outlook or on CreditWatch with negative implications) so far this year (see chart 2). We expect limited margin and cash flow improvement in 2025 and 2026 for U.S. auto issuers. This is because of pressure on automakers and dealers to lower prices, persistently high research and development (R&D) requirements, and high wage inflation across the sector.

In our base-case scenario, we incorporate the following high-level assumptions:

• U.S. auto sales remain flat in 2024 at around 15.5 million units, and grow 1%-2% in 2025 and 2026, with sales approaching 16 million units.
• Average new vehicle prices fall about 6%-8% (from Sept. 30, 2024, levels) through the end of 2025 due to incentive activity from automakers and lower pricing at dealerships.
• Used vehicle prices fall 2%-3% (from December 2023 levels) in 2024 and by another 4% in 2025 as supply of two- to four-year-old vehicles remains tight following three years of pandemic-induced lower OEM production.
• The industry will exercise discipline while maintaining inventory levels of 50-60 days, or roughly 30% below pre-pandemic levels. This will ensure reduced pressure on automakers to raise incentives and lower prices, hence protecting their margins somewhat, even if consumer demand weakens over the next 18 months.
• For the U.S. automakers, we expect General Motors Co. (GM) and Tesla Inc.'s EBITDA margins will be slightly weaker relative to 2023 (see chart 3) mainly due to lower revenue growth, higher labor costs, and more discounting. Ford Motor Co.'s margins will improve compared to 2023 but with a high reliance on its Pro business, which offsets higher warranty costs.
• Supplier margins will likely keep improving gradually with increasing volumes and more moderate raw material and freight inflation and less supply-chain induced volatility for customers. However, headroom for suppliers is tighter as companies grapple with a combination of low volume growth, market share losses in China, less-than-full recovery of input cost inflation, and--for companies with powertrain and electronics or software exposure--portfolio transition risks.
• For auto retailers, we expect EBITDA margins will further decline in 2024 and 2025, gross profit per unit will continue to normalize with better new vehicle availability, and as new vehicle prices drop. Furthermore, we expect finance and insurance (F&I) income per unit to come under pressure as affordability remains a problem for consumers.

Chart 2

Chart 3

With Increased Pricing Pressure, Inventory Management Will Be Critical

New vehicle prices remain about 30% above pre-pandemic levels in the U.S. so far in 2024; average transaction prices were around $44,467 in September 2024 per J.D. Power. However, we expect prices will decline by about 6%-8% over the next 15 months as incentives continue to increase and consumers opt for lower trim versions and more entry-level segments.

We believe volatility in automakers' sales (see table 2) could persist over the next few months, especially because of the differences in inventory levels across automakers. We expect most automakers with products skewed toward light trucks, particularly pickups, will target 50-60 days of total dealer inventory on a portfolio basis (see chart 4). This is down more than 30% compared to pre-pandemic levels of 80-85 days (in mid-2019) for light-truck-focused automakers.

Table 2

Light-vehicle inventory at dealerships reflected a 55-day supply, up from 40 days a year ago, and a pre-pandemic range of 60-80 days. There is some divergence across OEMS, as some companies like Stellantis and Ford have higher inventory days while Toyota still has very low days' supply. Thus far, the high level of inventory at Stellantis has not significantly hurt pricing or demand for competitors' products that benefit from newer products at attractive price points.

Chart 4

We Expect Pickup Truck And CUV Segments To Remain Strong

Full-size pickup truck market share decreased to 13.1% for the first nine months of 2024 from a peak of 15.5% in 2020 as sales of full-size pickup trucks fell 3.3% year over year. However, the share still represents an increase from the 11%-12% share prior to 2015 (see chart 5).

Historically, pickup truck demand has had a strong correlation with housing starts. With still elevated levels of interest rates, we expect housing starts will remain flat for several years at 1.3 million-1.4 million, down significantly from 1.6 million in 2021 and 2022.

While this could indicate a headwind for pickup truck sales, we expect the effects will be offset by pent-up demand in recent years (due to supply constraints) to replace aging pickup trucks. We also expect modest cannibalization from this segment toward the small and mid-size pickup truck segment, which has seen a resurgence in recent years.

The average age of vehicles in the U.S. remains at an all-time high of about 12.6 years in 2024, with an even higher average age for pickup trucks. This will likely support replacement demand for some older vehicles given the supply constraints over the past two years.

Chart 5

Crossover utility vehicles (CUVs) continue to gain share faster than the overall market, with sales increasing 5.8% in the first nine months of 2024; CUVs now account for 49% of the total light-vehicle market. CUVs have taken market share from passenger vehicles and larger CUVs have taken share from small SUVs.

Overall, across light vehicle segments, since 2010, the Detroit-3 automakers have lost some market share to Tesla, European automakers, and Japanese and Korean automakers (see chart 6). The share loss this year has principally been from Stellantis to other automakers.

Chart 6

Possible Tougher Financing Adds Risk

Lenders are still willing to support loans of over 72 months (nearly 29% of all loans at the end of the second quarter of 2024) to attract borrowers with lower credit scores. Moreover, they're frequently offering loans that exceed the value of the vehicle.

The downside risk is that it could prevent many buyers from re-entering the new car market for several years because vehicle owners who would usually trade in for a new model could end up owing more than the car is worth.

In recent years, several subprime borrowers delayed vehicle purchases as elevated vehicle prices, higher borrowing costs, and inflationary pressures affected their overall spending. We expect more subprime borrowers to reenter the market through 2026 as pricing conditions improve and financing rates subside somewhat. For instance, subprime loans as a percentage of all U.S. auto loans increased in the second quarter of 2024 to 16.7% from 15.8% in the first quarter. While this is worth monitoring, it is still lower than 17%-19% observed in 2009 after the Great Recession, and below the past 20-year average of 19.1%.

Auto loan delinquencies (over 90 days) have risen throughout 2023 across all age groups, though buyers aged 18-29 represent the highest delinquency rate. Notably, captive debt is predominantly owned by prime borrowers and has performed relatively well.

Superprime borrowers (with credit scores greater than 760) accounted for nearly 37% of all U.S. auto loan originations, the highest since early 2011 and a significant improvement from an average of about 22% in 2006 and 2007 (see chart 7).

Chart 7

Factors that will fuel demand include a higher level of incentives and subventions and attractive lease options that may help customers reduce the monthly payment. This could help manage the amount spent on motor vehicles and parts as a percentage of nominal U.S. disposable income. Recently, this has fallen from nearly 4% last year to 3.5% so far this year, likely due to some contraction in new and used vehicle prices.

Chart 8

After falling by around 7% in 2023, we expect used vehicle prices will only decrease 2%-3% (from December 2023 levels) in 2024 because demand for used cars has improved somewhat and supply of one- to five-year-old used vehicles remains tight. Recently, Carmax (the nation's largest used car retailer) reported a second-quarter comparable store sales increase of 4.3%.

We think unit volumes have recovered because of somewhat lower prices and relative value that used vehicles offer compared to new vehicles, which still have elevated prices. Going forward, lower pricing and lower interest rates could start to support a greater recovery in sales.

More Affordable EV Launches Will Boost Segment Share

Following a slowdown in market share gains for EVs and rising inventories for several models, we believe the next wave of buyers will remain more price sensitive and depend on material improvements in battery range, charging infrastructure and technology. We expect significant competitive pressure in 2025 and 2026 for all automakers. This is evident based on the large market share losses this year for Tesla's Model 3 despite multiple price cuts (see table 3). This could slow revenue growth and delay profitability parity for EVs relative to legacy products possibly beyond 2027, especially for issuers that do not achieve economies of scale.

We expect automakers will take a more measured approach on volume build-out through 2026 to avoid pricing wars for upcoming launches. We view GM and Ford's plans to scale back on EV capacity (relative to prior plans) and balance growth with profitability as slightly positive for credit quality over the next 12-24 months. This is because it appears to be an industrywide adjustment, and we believe both automakers will benefit from improved product mix (higher contribution from profitable internal combustion engine, full-sized trucks, and SUVs).

For suppliers that support EVs, we expect higher research and development spending and working capital in the form of tooling to support the launch of new products. While there is the potential for greater revenue opportunities from newer EV-related products, initially this transition will be a drag on supplier margins and free cash flow.

As a result of the production scale backs by automakers, we believe suppliers will take longer to achieve profitability on their EV products due to lower fixed-cost absorption. However, we expect suppliers will be able to lean on their combustion portfolio profitability for longer, thereby mitigating some of the impact of lower EV product volumes.

With manufacturer subsidies from the Inflation Reduction Act, investments in local supply chains, and tax credits, we still expect significant launches at more affordable price points. Together, we believe these factors will help reduce the U.S. EV market share gap with Europe and China by 2026, albeit at a slightly slower pace compared to our prior expectations.

Chart 9

Table 3

Related Research

• Global Auto Outlook: More Players, Less Profit, Oct. 9, 2024
• Credit FAQ: Inflation, China, And EV Transition Risks Casts Long Shadow On North American Auto Suppliers, July 22, 2024
• Industry Credit Outlook Update North America: Autos, July 18, 2024
• Industry Credit Outlook Update Europe: Autos, July 18, 2024
• Industry Credit Outlook Update Asia-Pacific: Autos, July 18, 2024
• Autoflash EMEA: Suppliers Feel The Heat Of Low Volumes And Earnings Pressure, July 1, 2024
• Rated China Carmakers Can Take The Heat From European Tariff Hikes On EVs, June 17, 2024
• Credit FAQ: Why China Is At The Center Of Global Auto Conversations, June 11, 2024
• CreditWeek: Who Will Emerge As The Winners And Losers Of The Electric Vehicle Adoption Race?, May 30, 2024
• China EV Startups Struggling To Stay Afloat, May 28, 2024
• Asian Auto: Resiliency Over Adversity, May 22, 2024
• Hybrids Prop Up Japanese Automakers, April 26, 2024
• Global Auto Sales Forecasts: Slower EV Growth Offers Temporary Relief To Legacy Automakers, April 25, 2024
• Tougher Pricing Conditions In 2024 Could Cramp U.S. Auto Sector Ratings Headroom, Feb. 12, 2024
• Industry Credit Outlook 2024: Autos, Jan. 9, 2024