Since mid-March, the coronavirus pandemic has caused financial whiplash in auto retail. Before COVID-19 precipitated an economic shutdown, US dealerships were tracking to near record earnings (see Chart I), approaching 2015’s peak profits. Dealers conveyed great optimism coming out of the February 2020 NADA convention. That optimism abruptly ended on March 15th as dealership showrooms shuttered and stay-at-home orders proliferated. Auto sales plummeted 15% in March and a further 39% in April.
As steep as the sales decline has been, there are reasons to be optimistic about the industry’s resilience in the face of a crisis. The flexibility and sustainability of the dealership business model has proven its ability to overcome the most challenging economic times. It is important to remember that even in the depths of the Great Recession, auto retailers remained profitable despite a 50% decline in new vehicle sales. Most critically, auto sales led the economy out of the Great Recession, outperforming total retail sales by 35% during the five-year period after the crisis and dealership earnings rose at a 31% compounded average growth rate (CAGR) from 2008 to 2012, 12.6 times faster than GDP growth during that period (see Chart II).
While today’s global health crisis is impacting auto retail in different ways from the Great Recession, these differences for the most part are to the benefit of the industry. Out of the gate, vendors, lenders and OEMS have provided dealers with tremendous financial support to ensure they weather the impact of lost sales. In addition, the Federal Reserve and the federal government moved at a record pace to guarantee the credit markets continued to function and businesses and consumers could stay afloat. The record pace with which the US government reacted to the coronavirus crisis contrasts notably with the Great Recession.
During this crisis, dealers have also accelerated their use of technology to increase sales per employee and improve operational efficiencies, while enhancing the customer experience. Perhaps it is for these reasons that Kerrigan Advisors has seen an unexpected surge in buyer interest in acquiring dealerships, at a notably higher level than we saw during the Great Recession. These investors see an opportunity for tremendous earnings growth in auto retail, not only due to a rebound in car sales, but also from reduced friction in the business model.
Given strong buyer demand and today’s low interest rate environment, Kerrigan Advisors does not expect a reduction in blue sky values in the foreseeable future, despite the economic impact of COVID-19 in 2020. In fact, valuations could rise by the end of the year, as earnings outperform downbeat expectations. If past is prologue, today may be the best time to invest in auto retail – that was certainly the case in the last recession.