Rising Vehicle Inventories in Detroit: Kelley Blue Book Analysts Weigh In

The problem: Automakers including General Motors GM and Ford F have too much unsold inventory. According to Jack Nerad, executive editor and market analyst at Kelley Blue Book, when inventories rise, incentives (discounts) are inevitable.

In an email to Benzinga Nerad said, “Behavior we have seen before seems to come back into fashion again and again, and that can now be said about incentives. Manufacturers say they are swearing them off, but when inventories get uncomfortably high, they roll them out again.”

In fact, higher than usual vehicle inventories in the winter are normal according to KBB senior analyst, Karl Brauer.

“Inventory levels always rise in January, though the cold weather last month clearly exaggerated the effect,” Brauer wrote. He added, “It’s too early to know if this represents a larger, fundamental issue or a short term bubble that will work itself out naturally.”

Brauer said the critical tipping point might arrive in February or later if excess inventories of large trucks like GM’s Silverado or Sierra “force it into an incentives play.”

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Kelley’s director of residual consulting From Eric Ibara, director of residual consulting suggested Detroit might take a more measured approach.

Ibara said, “As many experts are suggesting, a jump in days supply in January does not present sufficient evidence to proclaim the end of the momentum that has sustained the past four-year sales run. It does, however, present many manufacturers with an issue that requires a decision.”

While that decision, according to Ibara frequently involves the use of incentives to reduce inventory in the short term, adjusting production makes more sense over time.

“In the medium range,” Ibara wrote, “adjusting production to match market demand is the best way to preserve both new car transaction prices and used car values. The trade-off between margin and volume will be different for each manufacturer but the resulting impact to its brand can be difficult to predict.”

Detroit’s attempts at a balancing act – between margin and volume – pointed out by Kelley’s Ibara is what makes investors nervous.

According to The Wall Street Journal that investor skittishness has also been hurt by the fact that U.S. new-car sales growth has started to level off.

Industry sales should top 16 million this year, an increase from 15.6 million in 2013, but the percentage of increase will likely fall below that of recent years.

At the time of this writing, Jim Probasco had no position in any mentioned securities.