Auto retailers have commonly averaged the last three years of earnings to estimate expected future profitability. This methodology proved to be an effective predictor of future earnings for the years leading up to the pandemic (see Chart 1). However, beginning in 2020, when earnings commenced their hockey stick progression, the calculus for estimating future earnings based on the last three years of profits started to miss the mark. Buyers and sellers have since struggled to determine future earnings given the seemingly unpredictable nature of the industry post-pandemic. It appears that the past is no longer prologue, and a new methodology for earnings projections is required.
Today, Kerrigan Advisors finds most buyers are eschewing historical earnings in determining blue sky value. As an alternative, many are beginning to project future profits based on their expectations for future profit margins, assuming front-end gross margins normalize at levels higher than the pre-pandemic period, and post-pandemic operational efficiencies are retained. In so doing, these buyers are often averaging historical margins, rather than historical profits, and then applying that average margin to current revenue to project normalized profits for valuation purposes. This methodology often results in a normalized net-to-sales expectation between 4% and 5%. When applying those margins to current revenue, blue sky values range between 3.00 and 8.75 times of normalized profits and between 15% and 35% of current revenue (see Chart 2).
This approach of applying normalized profit margins to current revenue to determine expected future profits and ultimately blue sky is consistent with how Wall Street appears to be valuing the public companies (see Chart 3). Assuming lower net-to-sales levels between 4% and 5% on current revenue, the publics are trading at blue sky multiples consistent with their historical blue sky multiple average.
As with everything since the pandemic, the valuation model for blue sky will continue to evolve as profits normalize in the coming quarters. Kerrigan Advisors believes until the average of the last three years of earnings reflects the expectation for the next three years of profits, buyers will apply their own assumptions on normalized profit margins to current sales to determine the blue sky price they are willing to pay. How long this new valuation methodology lasts depends on how long it takes for earnings to become more consistent from year to year, whether that is on the way up or on the way down.
Kerrigan Advisors is the premier sell-side advisor and thought partner to auto dealers nationwide. The firm advises the industry's leading dealership groups, enhancing value through the lifecycle of growing, operating and, when the time is right, selling their businesses. Kerrigan Advisors has represented some of auto retail's largest transactions and advised more of the largest dealership groups in the US than any other buy/sell firm in the industry. Led by a team of veteran industry experts with backgrounds in investment banking, private equity, accounting, finance and real estate, the firm does not take listings, rather they develop a customized approach for each client to achieve their personal and financial goals. In addition to Kerrigan Advisors' sell-side advisory and capital raising services, the firm also provides a suite of consulting services including growth strategy, market valuation assessments, capital allocation, transactional due diligence, open point proposals, operational improvement and real estate due diligence.
Kerrigan Advisors monitors conditions in the buy/sell market and publishes an in-depth analysis each quarter in The Blue Sky Report®, which includes Kerrigan Advisors' signature blue sky charts, multiples, and analysis for each franchise in the luxury and non-luxury segments.—To download a preview of the report, click here.—The firm also releases monthly The Kerrigan Index™ composed of the seven publicly traded auto retail companies with operations focused on the US market. The Kerrigan Auto Retail Index is designed to track dealership valuation trends, while also providing key insights into factors influencing auto retail.—To access The Kerrigan Index™, click here.—To read the—2023 Kerrigan OEM Survey, click here.—Kerrigan Advisors also is the co-author of NADA's Guide to Buying and Selling a Dealership.
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