Auto sales around the world picked up in recent months largely due to generous government incentives. Now that many of those incentives are winding down, is there enough natural sales growth in the market to move the industry back into the black?

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While the recessionary sales slump may have bottomed out, the sluggish demand expected over the next few years is unlikely to turn things around for an industry that still hasn't tackled the issue of excess capacity in a meaningful way.

Cash For Clunkers "Sugar High" Now Over
In the U.S., the "Cash For Clunkers" program, which offered consumers incentives of between $3,500 and $4,500 to trade up to a brand new car helped push sales up to an annualized rate of about 14 million a year with the primary beneficiaries being Ford (NYSE:F), Toyota (NYSE:TM), Honda (NYSE:HMC) and Hyundai. Both GM and Chrysler saw their sales decline.

More recent industry sales data now reveals that the incentives may have brought forward sales that would have otherwise happened in the fall. Early September sales have decelerated sharply to a roughly 8 million a year pace.

Competition Heats Up In The Face of Weaker Sales
This post-incentive slump now looks like it has triggered a major competitive battle between GM and rival Toyota. GM's recent launch of an unprecedented 60-day money back guarantee promotion has been quickly followed by a reported $1 billion ad blitz by Toyota later this year targeting the U.S. market. With analysts projecting a fairly anemic sales rate of 10.5 million units in the fourth quarter, this "Clash of the Titans" could go over like a damp squib as most dealers now have limited inventories in the post-incentive period and average unit prices are up by $500 to $1000.

These higher prices are likely to produce negative comparisons in the minds of many consumers whose expectations on price were likely shifted downward during the incentive period. The net result of all of this could be higher expenses, disappointing sales and weaker profits for the combatants. (For more on analyst expectations, be sure to read Analyst Forecasts Spell Disaster For Some Stocks.)

Full Recovery Still Years Away
Visibility regarding the sales outlook beyond the next six months has recently emerged from European auto industry execs pitching their products at the Frankfurt Auto Show. While European car sales were up 3% in August, also in part due to incentives, many execs were quoted as seeing little chance that sales would return to 2007 levels until at least the 2014 to 2015 time period.

In the meantime, the industry must try to figure a way out of the massive glut in excess capacity now plaguing the European car makers. Forecasters now expect them to build only 17.7 million cars this year; 10.4 million units less than their factories are capable of turning out. Moreover, analysts now see the recent deal wherein GM sold a majority stake in its European Opel unit to a consortium led by Canadian parts-maker Magna (NYSE:MGA), financed in part by massive German government subsidies, as doing little to correct the overcapacity problem.

China On The March
So while U.S. and European auto makers look like they'll continue struggling for years to come, the industrial power-base of the industry appears to be shifting eastward to China. Over the last few years, they appear to have been quietly gearing up for this moment, gaining market share by buying brands like the U.K.'s MG-Rover and now being reportedly on the prowl for GM's Hummer and Saab.

In their domestic car market, which is now the largest in the world, they acquired key technological expertise through partnerships with big names like VW, Ford, Daimler (NYSE:DAI) and Hyundai. With their production now in excess of their domestic demand, China's car and auto parts makers have been aggressively pushing into foreign markets. The recent move by the U.S. to slap a prohibitive tariff on the import of Chinese tires, thus risking the ire of its major creditor, reveals the seriousness with which the U.S. views the Chinese competitive threat to the U.S. manufacturing base.

The Bottom Line
It's not your father's auto industry anymore. While massive government intervention may have saved the industry from sliding into the abyss, the real problems of excess capacity, below trend sales and rising third-world competition are likely to hobble industry profitability for years to come. (Learn what else to consider before investing in this industry in our article Analyzing Auto Stocks.)

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Tickers in this Article: F, TM, HMC, MGA, DAI

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