In recent months, industry articles and editorials have suggested that the long bull run in the buy/sell market has come to an end. We beg to differ. In fact, these recent opinions are not backed by data. In the first quarter of 2019, transaction activity actually rose 39% over 2018 (see Chart I). And, the number of multi-franchise transactions remained high at 14 (see Chart II). These are not signs of a slowing marketplace.
Clearly, dealers today are facing a tougher operating environment versus the halcyon days preceding 2016 when SAAR was growing at an average annual rate of 7.5%. Today, monthly SAAR is flat or declining, costs are up and interest rates have ticked up from record lows. But, that is not the whole story. Average dealership revenue and profits remain near record highs and overall industry health remains solid.
For many dealers, March and April were the best months of operating performance in years. Dealers have shifted their focus from new car sales to other, more resilient parts of the dealership business model. Those dealers who have grown used, F&I, parts and service have fared very well during this period of declining new car sales.
From our vantage point, these good operators who have shifted their focus are thriving. In fact, some strong dealers have more cash in the bank than they could possibly ever spend. They are opportunistically buying stores, and in some cases, biding their time to see how the macro-economic cycle plays out. These operators are focused on expense control given low topline growth, and the lower margins associated with the new car department. And, as always, they are growing the countercyclical parts of the auto retail business model.
While some investors and operators are worried about the sales downturn, recall that auto retail generally bounces back very quickly. The best example of this is how dealers brought down expenses rapidly in reaction to the financial crisis of late 2008, remaining profitable, and even increasing net to sales over prior years (see Chart III). Auto retail quite simply is a resilient industry.
In our experience, the transaction environment remains active and healthy, with transaction volumes up year over year (see Chart I). Valuations are high, particularly when including dealership real estate which is selling at peak valuations (see Chart IV). In recent months, our firm has had an all-out bidding war over a top luxury franchise in a major metro. We have put three dealerships under contract at the highest end of Kerrigan Advisors Blue Sky Multiple range. Contrary to some industry commentary, for quality franchises, we are not seeing a soft buy/sell market.
As I have noted in prior Dealer Magazine articles, there has been a flight to quality in recent quarters, but that does not mean the market is weak. Buyers are very aware of the unusual length of this economic cycle and are thoughtful about their capital allocation. They are willing to step up for excellent opportunities, as defined by the intersection of brand, facility, location and performance. But, they are shying away from some franchises, particularly those reliant on high-volume, new car gross, and stair-step programs.
There have been a handful of recent national stories of financial distress within the dealer body. In a highly fragmented industry, there are always examples of entrepreneurs getting upside down. After 10 years of growth, historically low interest rates, and unique access to credit, it is not a surprise that some dealers have gotten overly indebted.
In one case, a dealer had built an organization with multiple lower quality brands, became overly reliant on one strong cash flowing store to fund the overall enterprise, and simply became overextended with facility and real estate debt. Other cases have been just bad business practices, including being out of trust and undercapitalized. However, in today’s environment, these are the exceptions, not the norm.
To borrow an oft-used phrase, yesterday is history, and tomorrow is a mystery. Today is a gift and that’s why it’s called the present. This aptly sums up our situation in automotive retail today. It’s not perfect, it’s not ideal, and it never will be. But, the overall operating environment is positive and attractive deals continue to get done. We do not make predictions as to how long this cycle will run, but we recognize it for what it is – a good time to be in auto retail.