CLINTON, Iowa & IRVINE, Calif. -

As Japanese inventories in the U.S. get back to full steam, some experts are predicting that an incentive war could heat up between these automakers and domestics. Japanese OEMs and dealers have their sights set on making up lost sales, while their domestic counterparts are looking to continue their sales momentum, meaning the market could be ripe for consumers to benefit.

In fact, Kelley Blue Book is predicting an incentive war in the fourth quarter, but exactly what are dealers thinking on the frontlines? Auto Remarketing reached out to Japanese and domestic franchised dealers to get their take.

John McEleney, president of McEleney Autocenter in Clinton, Iowa, and McEleney Autoplex in Iowa City, Iowa, is actually seeing incentives levels retreat — at least right now.

“My understanding is that incentives for September, at least from GM and Toyota, my two main manufacturers, have actually been dialed back,” said McEleney, who serves as Iowa’s state director to the National Automobile Dealers Association.

“I know typically this time of year some of the residuals drop and some of the costs of leasing go up. That was our reaction, at least in the short term, was not to see them increase but seeing them go down,” he continued to Auto Remarketing.

“On the other hand, I wouldn’t be surprised if Toyota gets back to normal production levels and Honda some of the others affected by the earthquake, they will get very aggressive again in the fourth quarter, particularly with Toyota’s introduction of the new Camry,” McEleney surmised.

McEleney said inventory at his Toyota store bottomed out in July and August.

“That used up what was in the pipeline at the time,” McEleney noted, adding that the March natural disasters in Japan “was something nobody could have anticipated or planned for.”

With Toyota planning a big splash to push the 2012 Camry, the Iowa dealer thinks that’s part of what could be fueling Kelley Blue Book’s projection for strong incentive activity during the fourth quarter.

“I think they’re going to get very aggressive in the fourth quarter. They’re building a lot of the Camrys now in Kentucky. I think we’ll have good availability at launch,” McEleney told Auto Remarketing.

“I think they’re going to get behind that very strongly and launch that with some fairly healthy incentives. Although I think they might reduce the prices pretty significantly as well,” he added.

Several hundred miles due south of McEleney’s stores is Town & Country Dodge Chrysler Jeep in Shreveport, La. Marshall Hebert and his family operate the store and has a little different take on what his domestic supplier might do.

“Mainly I think they don’t want to lose the momentum that they’ve gained. I think Chrysler, for a change, will be the last one to come to the party,” Hebert shared with Auto Remarketing.

“They’ve been up 20 to 30 percent over the last three or four months. You might say that’s over nothing, but anytime you’re selling and you’re going from 60,000 to 70,000 cars to over 100,000 cars a month, things are pretty good,” added Hebert, NADA’s state director for Louisiana.

No matter what incentives Toyota, Chrysler or any other automaker might roll out, McEleney believes he and his franchised brethren are prepared.

“Based on all of the data we see from NADA and 20 groups and some from the manufacturers, dealer profitability has been pretty strong,” McEleney indicated.

“Dealers have found ways to reduce their break-even point. Interest rates are low so the cost of carrying inventory has been in line. While we’re not breaking records, most of us, the average dealer has found ways to make money on volumes that historically would not have yielded great profits,” he continued.

“We want the fourth quarter to be as good as possible, but on a profitability side I think most dealers are pleased with what’s occurring,” McEleney added.

KBB: Japanese, Domestic Incentive Battle Imminent

Meanwhile, Kelley Blue Book anticipates strong incentives late in the year in the form of cash and attractive lease offerings.

As the Japanese replenish inventory and begin to “throw cash on the hood,” Alec Gutierrez, KBB’s manager of vehicle valuation, expects to see the domestics follow suit, setting off an “incentive war.”

“While Hyundai and Kia would love to ramp up incentives to maintain competitive pricing, they don’t have the inventory necessary to significantly increase sales,” Gutierrez shared in KBB’s September Blue Book Market Report. “They simply do not have the production capacity to satisfy current demand for their products as evidenced by their ultra-lean 19-day supply of vehicles currently available to consumers.

“Consumers in the market for a new vehicle will likely find plenty of attractive deals in the latter part of the fourth quarter,” he added.

While the earthquake in Japan halted sales recovery earlier this year, KBB contends the anticipated push by the Japanese to recapture market share will likely help sales later this year.

“Since May, Japanese brands have given up considerable market share to both domestic and Korean manufacturers,” Gutierrez explained. “Prior to the earthquake, Japanese brands were consistently capturing close to 40 percent of all United States sales, but since April they have seen their monthly share of sales dwindle to nearly 30 percent.

“As Japanese production facilities return to full capacity in the near future, expect to see strong incentive support from these manufacturers as they aggressively try to recapture lost market share,” he projected.

In addition to increased incentive spending during the fourth quarter, KBB pointed out many highly anticipated redesigns will be hitting U.S. shores for the first time.

As McEleney mentioned, the 2012 Toyota Camry is expected to join the Honda CR-V and Civic as just a few of the major redesigns either just hitting dealerships or expected to hit dealerships later this year. Gutierrez acknowledged typically these Japanese redesigns are strong sellers, But this time around, he thinks they’re entering a much more competitive market.

“In the compact segment, the Civic will face strong competition from the all-new 2012 Ford Focus, new for 2011 Hyundai Elantra and the hot-selling Chevrolet Cruze,” Gutierrez surmised.

“In fact, the Cruze has been the best performing seller in the segment for the past several months and on a year-to-date basis the Cruze only trails the Corolla by slightly more than 1,000 units for outright segment leadership,” he recapped.

“While increased supplies, lucrative incentives and new product should certainly help the Japanese improve their sales figures, they are facing an aggressive market,” Gutierrez estimated.

Fuel-Sipping Models Expected to Drop Additional 6 to 8 Percent by Year End

In other elements of the September Market Report, KBB determined fuel-efficient vehicle values dropped 3 to 5 percent in August, marking the third consecutive month of declines for the segment.

Since June, analysts calculated values for subcompact and compact cars have fallen approximately 8 percent or about $1,000, while values for hybrid cars have plummeted 12.5 percent or about $2,200.

“The 2010 Toyota Prius has been especially hard hit, dropping $5,700 from June through September, due to rising gas prices and increased interest from franchised dealers looking to supplement their lack of new Prius inventory,” Gutierrez surmised.

Kelley Blue Book stressed that even with the significant drop since June, values for the fuel-efficient segments are still up $1,400 since Jan 1.

“While there have been considerable drops throughout summer, overall values for compacts and hybrids remain 12 percent and 5.6 percent higher, respectively, than the beginning of the year,” Gutierrez explained.

“However, don’t expect values in this segment to remain elevated. During the past several months, we have been stressing that values for fuel-sippers are likely to continue to fall and at this point we believe values will decline an additional 6 to 8 percent by year-end,” he continued.

Moving forward, KBB contends there are three factors that will contribute to the drop in fuel-efficient vehicles:

—Rental Volume Returns to Auction: Beginning in September, analysts mentioned rental car companies typically increase auction sales as they begin to unload last year’s models in anticipation of new inventory coming in.

“Since volume picked up during the past few weeks, expect values of fleet heavy models such as the Chevrolet Aveo and Kia Rio to be particularly affected,” Gutierrez projected.

—Fuel Prices on the Decline: KBB pointed out fuel prices have declined nearly 40 cents per gallon since their May peak and the firm expects more relief at the pump in the coming months.

In July, the Energy Information Administration (EIA) projected that fuel prices would decline to $3.46 per gallon by year-end and at the time oil was trading at approximately $95 per barrel with an expectation for $99 oil by December.

“Today, oil is trading at nearly $90 per barrel and if oil remains below EIA’s estimate, we could see gas prices drop below $3.50 per gallon by year-end,” Gutierrez computed.

—Return of Japanese Inventory: While rising fuel prices caused the unsustainable rise in values for gas-sipping vehicles, Kelley Blue Book emphasized the earthquake in Japan and ensuing inventory crunch only added fuel to the fire.

“Franchise dealers supplementing their new-vehicle inventory shortfalls this year with used-vehicle sales, will be less compelled to head to the auction as Japanese vehicle production and availability continues to improve,” Gutierrez said.

Dealers Cannot Afford to Ignore Compacts

Since Kelley Blue Book is projecting fuel-efficient vehicle values to continue to decline for the next several months, Gutierrez insisted dealers should refrain from overbidding on these vehicles at auction.

“While this may sound simple, the market can be quite deceptive,” he cautioned.

“Demand for fuel-efficient vehicles is likely to remain steady with gas prices currently above $3.60 per gallon, especially in markets such as Chicago and Los Angeles, where gas prices are close to $4 on average,” Gutierrez continued.

While consumers are interested in these models, KBB believes they are less willing to pay the high prices in today’s used-vehicle market.

“With freshly revised compacts such as the 2012 Ford Focus, Honda Civic and Hyundai Elantra available, with attractive lease offers below $200 per month, consumers have less incentive to pay top dollar for a used vehicle,” Gutierrez explained.

“However due to low supplies of these vehicles, many consumers will need to wait to take delivery and for those unable to wait, used cars will remain an attractive alternative,” he went on to note.

With that situation in mind, Kelley Blue Book is advising dealers to maintain a lean days’ supply of fuel-efficient vehicles while refraining from building up an excess inventory that cannot be sold in less than 30 to 45 days.

Gas-Guzzler Drops Will Not Exceed 2008 Levels

While values of fuel-efficient vehicles have declined after a strong surge early in the year, KBB pointed out full-size trucks and SUVs have depreciated steadily throughout 2011.

Since the beginning of the year, analysts determined full-size trucks and utility vehicles have dropped 5 to 6 percent; “a modest figure, but still more significant than any other segment,” according to Gutierrez.

“With fuel prices in excess of $3.60 per gallon, demand for gas-guzzlers has remained relatively soft,” he added.

With that said, the depreciation Kelley Blue Book has witnessed to-date “pales in comparison” to the dramatic drops that occurred in 2008 when these vehicles contributed to a significantly larger portion of the overall market.

Since 2008, analysts indicated trucks and SUVs sales have fallen and as a result they are a smaller percentage of the overall vehicle pool.

“Due to reduced availability of these vehicles in the market today, values may continue to depreciate, but they will not exceed 4 to 5 percent by year-end,” Gutierrez estimated.

SAAR to Remain Below 13 Million for Foreseeable Future

Kelley Blue Book recapped that the recent volatility in the financial market, coupled with the downgrade of the U.S. debt rating, were enough to drive down the Conference Board’s Consumer Confidence Index to 44.5 in August, a 14.7 point drop from July.

“This is the lowest recorded measure since 2009, when consumer confidence was threading toward recovery on the tail end of the previous recession,” Gutierrez mentioned.

After the drop in August was announced, KBB said many feared that new-vehicle sales would be significantly impacted.

“In addition, Hurricane Irene swept across the East Coast limiting potential sales further. The hurricane kept many consumers in that region away from new-car dealerships potentially reducing sales by 10 percent, according to some estimates,” Gutierrez noted.

After the dust settled and sales reports came in on Aug. 1, Kelley Blue Book found that new vehicles sold at a 12.1 million sales pace for the month.

“While this is not record breaking, it is an improvement from the woeful sales figures reported throughout 2009 and much of 2010,” Gutierrez acknowledged.

Sales were up 8 percent year-over-year overall, according to Kelley Blue Book, with especially strong performances from domestic brands — Chrysler (up 31 percent), General Motors (up 18 percent) and Ford (up 11 percent).

Among the import brands, KBB noted Hyundai continues to do well, improving 16 percent, while Nissan jumped a healthy 19 percent.

“The 16 percent improvement from Hyundai is especially impressive considering they had a 19-days’ supply of inventory to start the month of August,” Gutierrez surmised.

Conversely, KBB mentioned Honda and Toyota continue to face inventory issues as their sales declined 24 percent and 13 percent, respectively.

“Although sales in August came in above a 12-million SAAR, we do not expect a long-term sales recovery just yet,” Gutierrez cautioned. “The industry still faces tremendous challenges, so it may be some time before we see sales in excess of 13-million units per year.

“High unemployment, a weak housing sector, low consumer confidence and low inventory levels are a few of the hurdles preventing the industry from returning to the 16- to 17-million unit sales figures from the glory days,” he explained.

“One thing is clear, although many of these economic indicators remain negative, they have remained relatively stable indicating that sales should at least continue to trend in the 12- to 13-million unit range for the foreseeable future,” Gutierrez stressed.

Unemployment, Consumer Confidence Strong Indicators of Future Vehicle Sales

Upon review of current market data, Kelley Blue Book analysts found consumer confidence and unemployment data are highly correlated to new-vehicle sales.

“Although consumer confidence took a significant hit last month, it may turn out to be a short-term reaction to the high volatility in the equity markets during August,” Gutierrez projected.

“Consumer confidence may recover slightly in the months ahead, but we don’t expect a significant improvement given the continued weak housing market and an unemployment rate above 9 percent,” he went on to say.

“That being said, Kelley Blue Book expects that new-vehicle sales will continue to follow suit, with only a slight uptick. Even with instability in the consumer confidence rating through the last 12 months, we expect to maintain a sales pace above 12-million units per year in the short term,” Gutierrez added. “We have seen an improvement from 2009 and 2010, yet don’t expect sales in excess of 13-million units per year until housing and unemployment rates improve considerably.”

Housing Weighs Heavy on Consumer Confidence

KBB reiterated the housing market has weighed heavy on consumer confidence and remains a significant hurdle for recovery in the automotive sector. Analysts said sales of new homes remain at historic lows and the average sale price of a new home has been relatively flat after a steep drop off in 2007.

“When the housing bubble collapsed, many households took a significant hit to their overall net worth for the next few years after the housing market had been touted as a safe investment,” Gutierrez  indicated.

“With many consumers still upside down on their current home and no recovery in sight, the soft housing market will continue to keep consumers weary of committing to purchases of big-ticket items such as new cars,” he concluded.