In a recent piece, Bloomberg journalist Keith Naughton laid out a wonderful counter-argument to the consensus of opinions for what the future looks like. His piece, “Millennials Could End Up Being a Boon to the U.S. Auto Market,” talks about the good news of the auto businesses future via Benchmark analyst Mike Ward’s research. “As the generation born between 1981 and 1996 begins to reach their family formation years, they are getting licensed to drive at the highest rate in 40 years.” We found this oddly interesting for us as investors because this isn’t being talked about by others on Wall Street. On the contrary, the last few years have been all about peak auto sales and declining demand for fossil fuels far into the future.

Mr. Ward’s work aligns directly with our firm’s research over the last few years that consumption is changing at a much faster rate than is being reported. Below is a chart that we got from the folks at Fundstrat showing what the millennial growth of consumption will be (in grey). The blue column shows what the millennials’ share of the future growth is estimated to be. When you focus in on “Gasoline and motor oil,” “Vehicle purchases” and “Vehicle leases,” you can see that millennial consumption is projected to roughly double across these categories and their share of growth in these spending categories would be 55% - 59%.

Ward put together the chart to the right showing the growth in licensed drivers over five-year periods since 1974. He surmises that this could create an extra three million car purchases per year. Ward was in agreement with us when he stated, “The key demographic of people aged 35-44 years continues to grow until 2034 and could provide growth for the industry for the next decade.”

Adding to the total sales of the industry is a continuing change in the mix of cars produced. In a 2018 piece that Keith Naughton and a few of his other Bloomberg colleagues contributed to, they wrote that, “With lucrative sport utility vehicle and truck sales on the ascent, Detroit automakers are racing to ditch slow-selling cars in favor of the big rigs that mint them money.” Sedans are disappearing in the US auto market, replaced by SUVs particularly. Millennials love four-wheel drive and the versatility that comes with it. This brings two things: larger margins compared to cars and more gasoline consumption compared to a Prius. As an example, most consumers think of the Porsche brand as a sports car company. However, they are doing more than 60% of their total vehicle sales in SUVs via the Macan and Cayenne. These are by no means very fuel efficient compared to the cars they produce. If housing has taught us anything about millennials, it is that the longer the wait, the more they spend. This especially plays to SUVs and more expensive brands, in our opinion.

Think of how far we are away from 2008, where oil prices were high and no one wanted to buy a gas guzzler. Now, compact cars are dying on the vine and oil is 40% of its prior peak. Using back of the envelope math, we believe that the 16-year-olds in 2020 that have a driver’s license will grow over 6% per year and peak in their 30’s as the data is proving for people who are 35-39 now.

This gives us immense confidence for the circumstances around the businesses that benefit from this growth. We have been building a position in Occidental Petroleum (OXY) as they can export up to 60% of their oil abroad and are ultimately at the mercy of global oil prices, not domestic US energy pricing. There will be a positive correlation between auto purchases, miles driven and the oil demand thanks to growth in consumption that the millennials produce. Don’t forget, the primary use of oil isn’t consumer cars and trucks. It’s airlines, trucks and other oil demand.

Why this car is automatic
It's systematic
It's hydromatic
Why it's greased lightnin'!

Our car theory is automatic because everyone ages, even millennials. It’s systematic because it’s directly correlated to 30-year old’s in the years of household formation. It’s hydromatic because, like the Hydra-Matic transmission first created by GM long ago, they will only be using automatic transmissions. SUVs today don’t have stick shifts. The demand from millennials won’t be met through electrical technology for decades. It doesn’t matter how much attention Greta gets at Davos. To harken Steve Mnuchin, it’s nothing different than any economics lesson. Demand goes up, price must adjust. The need will be met primarily through oil, but will have a mix of hybrid and electrical too. It’s “Greased Lightnin’.”

Warm regards,
Cole Smead, CFA

The information contained in this missive represents Smead Capital Management's opinions, and should not be construed as personalized or individualized investment advice and are subject to change. Past performance is no guarantee of future results. Cole Smead, CFA, President and Portfolio Manager, wrote this article. It should not be assumed that investing in any securities mentioned above will or will not be profitable. Portfolio composition is subject to change at any time and references to specific securities, industries and sectors in this letter are not recommendations to purchase or sell any particular security. Current and future portfolio holdings are subject to risk. In preparing this document, SCM has relied upon and assumed, without independent verification, the accuracy and completeness of all information available from public sources. A list of all recommendations made by Smead Capital Management within the past twelve-month period is available upon request.

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