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Thursday, November 20, 2008

RV Investor

RV Index Continues to Slump

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In The Economy and RV Sales we identified a number of macroeconomic factors that correlate with RV industry retail sales. RV Investor has developed a simple, objective, model that incorporates these factors to predict retail recreational vehicle sales. Furthermore, the inputs to the model can be easily obtained from numerous sources of macroeconomic data including the Congressional Budget Office, the Federal Reserve, and the Economic Report of the President. The Recreational Vehicle Industry Association (RVIA) is the best source for industry shipment data and trends.

The model is a simple regression model with each predictor assigned a weight based on historical correlation dating back to 1978. Gross Domestic Product (GDP) and Personal Consumption Expenditures (PCE) are the best predictors by far but we also know that interest rates, income tax rates, unemployment, and gas & oil prices as a percent of PCE all exert either upward or downward pressure on RV retail sales. But unlike our previous one year prediction, we have attempted to extend the same basic model and to further refine from 2006-2011.

Lets start with the basic assumptions that drive the model. These are based on key historic economic variables as forecasted by government agencies as listed above. None of the inputs were massaged. Regression analysis was used to correlate RV sales to these factors. Table 1 below summarizes the regression variables. Note the high correlation between GDP/PCE and RV sales and the sharp drop-off in correlation with the Prime Rate, Tax Rate, Unemployment and the percentage of PCE that goes towards Gas and Oil.

Table 1 - Regression Variables

Figure 1 below shows the correlation between GDP and RV Retail Sales. As you can see the correlation is quite good with an R² of 0.88.

Figure 1 - GDP vs. RV Retail Sales

Figure 2 below also shows that Retail RV Sales as a % of GDP has been climbing. In our opinion this is driven by favorable demographics as shown in Table 2.

Figure 2 - Retail RV Sales as a % of GDP have Averaged 0.09% Historically

The next most important factor with regards to RV Retail Sales is Personal Consumption Spending as shown in Figure 3. The correlation factor, R², is 0.89.

Figure 3 - PCE vs. RV Retail Sales

Likewise, Retail RV Sales as a % of PCE have also been growing as show in Figure 4.

Figure 4 - Retail RV Sales as a % of PCE have Averaged 0.14% Historically

Figure 5 below shows that RV Retail Sales have been climbing since the early '90s relative to GDP and PCE. We believe this is largely attributable to higher disposable income during the '90s economic boom aided by favorable demographics as shown in Table 2.

Figure 5 - RV Retail Sales $ Value vs. Percent of GDP and PCE

Interest rates actually play a larger role than indicated by the correlation (R² 0.25)to sales, especially with large ticket items such as Class A motorhomes or large towable trailers where the interest payment can easily exceed 75% of the cost of ownership. The Prime Rate that corresponds to the historical average of RV sales as a  percent of GDP (RVGDP% of 0.09%) is about 9%. In other words, when the prime rate is above 9%, it exerts downward pressure on RV sales whereas when it is below 9%, it is favorable for RV sales. Interest rates are headed upwards so we expect to see somewhat of a slowing effect on RV sales although we are still below the 9% level.

Figure 6 - Prime Rate vs. RV Sales as a Percent of GDP

Federal tax receipts as a percent of GDP play even less of a role as interest rates with an R² of 0.10. The rate that corresponds to our RVGDP% figure is 19%.

Figure 7 - Tax Receipts as a Percent of GDP vs. RV Sales as a Percent of GDP

Unemployment becomes a net drag on RV retail sales when it exceeds 6.25%. While the correlation factor is low at 0.10, high unemployment goes along with low consumer confidence and therefore less spending on large ticket items. The saying in the industry is that no one has to have an RV!

Figure 8 - Unemployment vs. RV Retail Sales as a Percent of GDP

With Oil prices North of $70/barrel and record increases at the pump, expect RV sales to take a hit in 2006 and going forward until prices at the pump stabilize. Historically, rapid increases at the pump have correlated with slowing or declining RV sales.

Figure 9 -Retail RV Sales vs. CPI Adjusted Fuel Prices

While not used explicitly in our forecast model, Census Bureau projections show that there will be growth in the prime demographics for RV buyers, particularly those in the 45-64 age group who tend to purchase the higher end towable trailers and motorhomes.

Table 2 - Census Bureau Demographic Projections

Table 3 lists the economic assumptions used in the model as mentioned earlier, these are from government forecasts, they too are subject to errors. The source of the errors are event that can not be predicted based on history - energy shortages due to war or poor policy, recessions, over exuberant markets that come crashing down later (like tulips or more recently dotcoms).

Table 3 - Economic Assumptions for Five Year Forecast

Tax rates, unemployment an gas & oil expenditures as a percent of total PCE definitely have a slowing effect on RV Retail Sales. However, the single most important factors that caused negative growth since 1979 are recessions and fuel crisis as illustrated in Figure 10 below. 1978-80 saw lines at the pump and double-digit interest rates. Even so, 1981 and 1982 managed to show some pretty good growth leading to a whopping 85% growth in 1983. The Gulf War and the early Clinton years lacked luster but as the 90's began to boom, so did RV industry sales, at least until the dot-bust of 2000-01. Over the 27 year period from 1979 to 2005, the industry saw 8 down years or 30%

Figure 10 - RV Retail Value Year on Year Change

Admittedly, there can be significant errors in statistical models that rely on historical data as their basis and forecasts or estimates, even short-term ones, as inputs. However, statistical models do not suffer from personal bias and its own peculiarities. Unpredictable events by definition can't be predicted: terrorist attacks, geopolitical events such as Iraq. the looming conflict with Iran and North Korea, earthquakes in California, hurricanes in the southeast. Not much that you can do other than to take the obvious protections that few practice.

From a business structure point of view, the key needs to be flexibility. In general, any RV business should be prepared to take advantage of 20-30% upturn in any given year as well as a 10% downturn that may last up to three years. Flexibility has to be part and parcel of a company's manufacturing strategy both internally as well as through the supply chain. This topic will be discussed in a separate article.

Figure 11 below uses simple regression analysis performed on nearly 30 years of historical data. All those of us with an MBA or who follow the market know that past performance is not indicative of future performance and that any given year may be higher or lower than the forecast based on unpredictable factors such as those mentioned above. Let's face it, modeling the macro economy and resulting consumer behavior is like predicting who will win the world series at the beginning of the season based on past season stats or even worse, trying to predict global warming based on CO₂ emissions with "input data" that has a larger error bar than the predicted change! [Editor: Global Warming is a natural process driven by much larger and more complex systems than the economy and we can't even accurately predict that! Sorry, but I couldn't resist taking a shot at that piece of junk science.]

Even so, RV Investor believes that as long as the assumptions are provided for all to see, the reader can make up their own mind. We would be happy to collaborate with anyone to modify / improve / or clarify the model to make it more useful.

We are forecasting a dip in 2006 simply because 2005 was an extraordinary year. Given the economic uncertainty, rising gas prices, and rising interest rates, we believe there will be a 6.2% dip with nominal growth of 5.3% expected to resume in 2007. Notice that I said nominal growth. Growth has never been nominal in the industry as pointed out earlier. The real takeaway message should be that while the RV industry is not a barnburner, that it will continue to see steady growth barring unforeseen events that effect the overall economy.