This year’s AutoTeam America Buy/Sell Summit and CEO/CFO Forum at the National Automobile Dealers Association (NADA) Convention and Expo brought together many viewpoints on the state of the industry, including those of brokers, bankers, industry analysts and reporters, family funds, private equity groups, attorneys, CPAs, and, of course, dealers.
In 2016, the seasonally adjusted annual rate (SAAR) finished at 17.55 million vehicles, up slightly from the prior year. Three hundred and forty rooftops were sold during the year compared with 472 in 2015 (down 28 percent). Much of this decrease was due to fewer transactions by the publicly traded groups, which bought approximately 10 percent fewer stores than they did in the prior year. Valuations continued to be strong.
The overwhelming consensus was that the industry is currently in great health and primed for at least another good year before seeing a slowdown. The following evidence, as reported by NADA, supports this optimism.
- The rise in employment in the past few years is fueling more demand for vehicles.
- Low interest rates are keeping the cost of capital down on major investments and, in many cases, turning net floor-plan interest into income when assistance paid by the manufacturers exceeds expenses incurred.
- Lower fuel costs are encouraging more driving and increasing demand for bigger, higher-priced, and higher-margin vehicles.
- Total annual miles driven increased for the third straight year (up 3.1 percent), which directly correlates to more demand for vehicles.
- Consumer confidence is the highest it has been since 2004, which is always good for vehicle purchases.
There are signs that although sales are up, the bottom line may not be growing at the same rate. Gross profit per new vehicle sold and gross profit per used vehicle sold both decreased. Even though finance and insurance income on a per-vehicle-sold basis increased, it was not enough to offset the decreases in vehicle margins. Fixed operations volume increased 5.7 percent, likely resulting from the strong vehicle sales of the last few years. However, expenses grew faster than margins due to higher facility cost – more advertising and overall less discipline in controlling expenses. Further, incentives paid by the manufacturers drove some of the volume during 2016. These incentives are starting to go down.
The success the industry has experienced as of late is expected to continue over the next two years due to the factors listed above, although it would be difficult to sustain the rate of growth experienced since 2010 due to much of the demand for new vehicles already being filled. Most analysts are predicting that the SAAR will be down to around 17.1 million, although some are saying it could reach as high as 18 million units in 2017. Analysts are predicting that the sales rate will remain high in 2018 before falling off in 2019.
Predictions for a downturn after 2018 are driven by several anticipated changes, including the following:
- Leasing is currently at an all-time high – around 30 percent compared to historical averages in the 20 percent range. These rates are likely to result in a high number of renewals that would increase price pressure on new vehicles.
- Gas prices likely are the lowest they will go and, as they rise, vehicle mix and affordability will be affected.
- The rapid growth in miles driven over the last few years is unlikely to persist and may result in lower demand.
- Like gas prices, interest rates are very low and are likely to rise in the future.
State of the Transaction Market
Consolidation also is expected to continue. With fewer dealers in the market and more units being sold, the throughput per dealership should continue to increase and drive good returns in the market. In addition, the retail dealership space is attractive for investors because volume, mix, and price all are positive and predicted to stay that way for the next couple of years. The industry’s demonstrated ability to not only survive the recent recession but recover from it in an extremely profitable manner, paired with the protection provided by strict franchise laws, makes dealerships attractive to buyers coming from a range of areas. Berkshire Hathaway’s successful entry into the market provided validation for potential buyers that the industry is a strong and viable investment opportunity.
PEGs and family funds offer needed expansion capital and, in most cases, a longer-term exit strategy, more buying power due to a multi-store framework, and more sophisticated management and processes. In addition, they are willing (and in most cases prefer) to retain the former owner or key operators as minority partners. These groups offer an alternative to the large dealer who, a few years ago, only had the option of selling to a publicly traded dealership group.
Although many in the industry agree that the number of transactions will decrease in 2017 due to the predicted decrease in profitability and the resulting transaction price expectation gap, a significant number of deals are still expected to close. Most of the brokers I spoke with at the conference commented that they have good pipelines and many transactions that are likely to close in the first half of the year.
- Dealers are naturally optimistic people and that optimism was evident at this year’s convention. At the same time, there is uncertainty in the air, mostly attributable to what might happen under the new administration. On the plus side, dealers believe that the promises of lower tax rates, domestic investment, reduced regulation, job growth, and better access to capital all bode well for car dealers. However, the threat of trade wars and a border tax or tariff on imports, higher labor costs, currency risk, and geopolitical uncertainty present potential headwinds. Time will tell how this plays out.
- Several different manufacturers, including Fiat Chrysler, Nissan, Jaguar, and Land Rover, have announced or are currently adding additional points to their dealer networks. This could have a large effect on the throughput and value of existing points.
- The used vehicle market remained hot in 2016 due to the high rate of technological advancements in new vehicles. These advancements are being released at such a rapid rate that older cars are becoming obsolete faster than ever. Drivers have a greater desire and need to update their vehicles more frequently to keep pace with new technology. However, analysts predict that the prices on used vehicles cannot be sustained indefinitely, and we will likely see a downturn in this department.
- Autonomous vehicles continue to be a topic of conversation. Most dealers agree that when these vehicles are fully developed, they will produce the biggest sea change the industry will ever go through. However, it also will take a long time for the country to see full implementation of this new method of transportation. Some experts estimate the cost of an infrastructure to support these vehicles could cost over $6 trillion. Who is going to pay for it? All kinds of issues need to be worked out, not the least of which is the vehicle-to-vehicle communication system that would be needed to make this work. If and when such a system is developed, there will be other issues to consider such as terrorist-type cyberattacks on the vehicles’ communication systems that could result in severe traffic accidents with fatalities. It is intriguing to imagine all the repercussions the new type of transportation will have on the market and society, but it is a long way off. In the meantime, it will be interesting to witness the evolution of autonomous driving.
Given all of the information coming out of the conversations at NADA this year, the next couple of years are expected to be good ones for retail dealers. Acquisition activity likely will continue, although it may not be as heavy, and valuations likely will come down. Economists and analysts are predicting a fairly dramatic downturn (as much as 25 percent) in the overall market as early as 2019. The new administration could have a big effect on the near-term market, depending on what happens with tax law changes and trade regulations.
Author: Ron Sompels
Ron Sompels is a partner with Crowe Horwath LLP.