Sticker shock at the petrol pump is prompting some car shoppers to reconsider their gas-guzzling ways, driving sales of fuel-efficient vehicles, but investors looking to capitalize on this will need to buckle up, because it may take a long time to profit off the trend.
As a category, hybrid vehicles, which use fuel-efficient combination gas and electric motors, are experiencing explosive growth thanks to rising gas prices. Sales of
Prius hybrid were up 700% year over year in the month of July, according to Ward's Automotive Research. In July, the car was the fastest-moving vehicle off of dealer lots for the 10th straight month, spending an average of six days there. The car is so popular that Toyota is boosting production by 50% to meet the rising worldwide demand and is unveiling a number of new models, making it a front-runner in the nascent space.
With gasoline prices 33% higher than a year ago as of Aug. 9 and consumers finally excited about a group of vehicles for reasons other than cheap financing and massive rebates, carmakers don't want to miss out on a potential trend.
"It's the fastest-growing category of vehicles in the past several years," said Jesse Toprak, director of pricing and market analyst at Edmunds.com. "There are a lot of products in the market coming in, like the Ford Escape, the Lexus RX400h -- they're all coming out with something."
new Escape SUV will hit dealer lots, becoming the first hybrid SUV and the fourth vehicle on the market. Toyota will also be putting out hybrid versions of the Lexus RX400, Highlander SUV and Sienna minivan in the next two years.
has a hybrid version of the Accord planned, while
debuts in the space with a hybrid Dodge Ram pickup. Even
, which lags rivals in this space, will make up for it by launching four hybrid vehicles by 2007.
The political climate favors hybrids, too, possibly because carmakers want to avoid a McDonald's-style backlash for producing gluttonous vehicles without offering alternatives.
Already, hybrid vehicle buyers can receive a $1,500 tax credit -- a perk that will expire in 2006 -- and politicians are moving to capitalize on the issue. Democratic presidential candidate Sen. John Kerry has made fuel efficiency a part of his presidential campaign platform, with a $10 billion plan to create an institute to study alternative fuels, while boosting average fuel economy standards and extending tax credits to consumers who buy fuel-efficient vehicles.
The state of California, a good barometer for environmentally friendly automobile standards, expects registrations of hybrid vehicles to more than quadruple by 2007, and it is weighing incentives for owners, such as free parking and special access to carpool lanes. If other states follow suit, a combination of high energy prices and government incentives could spur further consumer interest.
With carmakers investing so much in new models, especially larger vehicles, and word of mouth spreading fast, hybrid cars aren't going away -- they're only getting started.
Goodbye Guzzler? Not Likely
Overall sales of hybrids may be growing fast, but they remain miniscule -- much like their impact on carmakers' balance sheets -- especially with larger issues such as interest rate hikes looming over the industry. For the rise of hybrids to really have a bottom-line impact, investors will need the price of oil to stay high and a lot of patience to see how consumers react.
"It's still a niche vehicle," said Kevin Tynan, an analyst at Argus Research. "In 2004 and 2005, they'll account for less than 1% of the total vehicles sold. And in July, domestically, sales were split 55% trucks to 45% cars, so hybrids are certainly not driving the market. The market has not had a fundamental shift away from trucks -- our gasoline prices have not been high enough long enough for that to happen." (Argus Research has no investment banking arm, and Tynan does not own stocks in the companies he covers.)
Consumers aren't moving out of SUVs and into compact cars because both serve different purposes -- people won't suddenly opt for two-door hatchbacks if they need the space of a larger vehicle. Thus, high gas prices are forcing companies to offer incentives to sustain demand for the big guzzlers, while consumers move down to crossover utility vehicles, or CUVs, which are still large but get better gas mileage. In July, a month when prices at the pump peaked at $2.02 a gallon, sales of small cars rose just 1.2% -- less than the 3% rise in SUVs and 15% gain in CUVs.
"High gas prices affect incentives offered on SUVs, especially over the last five months," said Toprak. "We found there is a direct correlation with gas and the incentive dollars on the largest SUVs -- and that has kept demand stable. SUVs had a bad month in June, but they did very well in July. Looks like the love affair with large vehicles isn't over yet."
If the price of oil and gasoline falls to a more economical level, the move toward hybrids could prove to be a fad. In the late 1970s, consumers turned to Ford Escorts and Renault Le Cars in the wake of long lines at the gas pump, only to return to larger vehicles once the panic faded and prices fell.
With hybrid and other fuel-efficient cars employing sophisticated new technologies that have not been battle-tested, gas sippers could develop a bad reputation as brittle cars prone to expensive problems the local mechanic is ill-equipped to fix. The 2004 Vehicle Dependability Survey from J.D. Power and Associates found that owners of 2001 model Toyota and Honda hybrids -- the first hybrids to hit the market -- had twice as many engine problems as ordinary gas guzzlers. If word of mouth sours, new products could face an uphill battle.
Furthermore, savings from owning a hybrid vehicle may not add up as fast as the marketing implies, making it harder to justify paying a premium of more than $2,000 to buy one. At $2 a gallon of gas, it would cost about $730 a year to drive 20,000 miles in a 2004 Honda Insight, which gets 55 miles per gallon. That's about $870 less than the cost of driving a 2004 Ford Focus, which gets about 25 miles per gallon -- perhaps not enough to offset the hefty premium.
Time, O Precious Time
While the hybrid boom may not be as powerful as some would suggest, carmakers aren't off track in betting on the emerging market for fuel-efficient vehicles. By expanding the technology from limited-use vehicles, such as the two-seat Insight, and into established brands, such as the Escape SUV, such vehicles could prove more popular with consumers than many expect -- a conclusion reached by a J.D. Power report early this year.
"The Insight is an absolutely hideous-looking thing, and the Prius is no Claudia Schiffer either," said Toprak. "But what you see with Ford's Escape, it at least looks like it has a regular combustion engine in it."
The Lexus RX400h may be a vision of the future, offering the best of all worlds on an established platform. Toyota, which delayed the launch of the car until early 2005 to ensure it can meet demand, not only claims the RX400h will get better gas mileage than the regular version -- with 28 miles per gallon to 21 miles per gallon -- but it will have better performance as well -- generating 270 horsepower vs. 230 for the combustion version.
As products improve, consumers may hop into hybrids, which are also quieter and cleaner, but ultimately, the price of oil will have to remain historically high to shift the industry dramatically. If oil goes to $50 a barrel and gas ramps to $6 a gallon, as it has in Europe, it would cost roughly $2,200 to fill up that Insight every year, about $2,600 cheaper than filling up a Focus, giving consumers a more pressing reason to consider the alternatives.
"If we're paying $4, $5, $6 a gallon, you might start saying you can't afford it anymore and move to hybrids," said Toprak. "But it's a gradual change."