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The 2019 Buy/Sell Market in Review and Expectations for 2020

2019 was the second most active buy/sell market since 2014 with 230+ completed transactions (see Chart I), an impressive accomplishment for a market that got off to a slow start.  In the first half of the year, transaction activity declined 9.6% and the publics’ acquisition spending plummeted 59.3%.  Going into the second half of the year, the market did an about face. Transaction activity gained momentum in the third quarter and boomed in the fourth quarter (see Chart II), making 2019’s second half one of the most active on record (see Chart III).  The buy/sell bulls overtook the bears resulting in a plethora of deal activity.

At the outset of 2019, buyers seemed weighed down by economic uncertainty, global trade disputes and 2018’s stock market declines.  However, as the year progressed, buyers gained confidence in the resilience of the dealership business model, particularly as earnings growth resumed and interest rates subsided.  After three straight years of declines, 2019’s average dealership profits reversed course  (see Chart IV), achieving the third highest earnings level on record, just 9.9% below 2015’s peak.  This trend reversal, which started in April, gave buyers greater confidence in their expansion plans and earnings growth expectations, leading to improved transaction pricing.

The rebound in dealership earnings was driven primarily by auto retail’s diversified business model, particularly the higher margin business segments, namely used vehicles and fixed operations.  In 2019, these two segments grew an impressive 2.5% and 4.4%, respectively.  As a result, the average dealership achieved a record $7 million in gross profit (see Chart V), despite a 1.1% decline in new vehicle gross profit, proving the resilience of dealership earnings during a period of declining SAAR.

“The diversification in our six core business lines [New, Used, F&I, Service, Parts, and Collision] creates resiliency in our revenue and profit streams.”
Bryan DeBoer, President & CEO
Lithia Motors
Fourth Quarter 2019 Earnings Call

Buyers’ renewed sense of optimism, coupled with rising dealership earnings resulted in a steady increase in blue sky values throughout the year (see Chart VI).  Higher blue sky values were also supported by lower interest rates which buyers leveraged to finance an increasing percentage of their acquisitions.  I believe buyers’ access to low cost acquisition financing was a key driver of 2019’s buy/sell market and will enhance 2020’s activity levels if the financial markets remain strong.

As with the private market, the publics also saw an impressive rebound in their valuations throughout last year.  After declining 29.8% in the second half of 2018, The Kerrigan Index™ rose an impressive 42.9% in 2019, outperforming the S&P 500 by 48.6%.  Wall Street investors are clearly attracted to auto retail’s countercyclical dynamics and the industry’s ability to grow profits even as new vehicle sales contract. Investors also see tremendous opportunity for earnings growth with continued industry consolidation.

Methodology
The Kerrigan Index™ is composed of the seven publicly traded auto retail companies with operations focused on the US market, including CarMax, AutoNation, Penske Automotive Group, Lithia Motors, Group 1 Automotive, Asbury Automotive Group and Sonic Automotive.
The Kerrigan Index™ is weighted by the market capitalization of each company and benchmarked at 100 on 1/3/2000.

The public auto retailers’ blue sky multiples are currently two turns above the average private dealer’s blue sky multiple (see Chart VIII).  This valuation spread renders most acquisitions accretive to earnings and makes a growth through acquisition strategy highly profitable.  Armed with higher stock prices, the publics are expected to increase their acquisition spending in the first half of 2020.  With the completion of Asbury Automotive’s $1 billion acquisition of Park Place Dealerships, the public auto retailers’ collective spending on US acquisitions could reach record levels in 2020.

While private and public buyers remain bullish on the future of auto retail, a growing pool of dealers are deciding it’s their time to exit.  Most of these dealers are concerned about the expected changes coming to the industry over the next decade.  These sellers are also concerned about threats to the franchise model with legislation potentially enabling direct OEM to consumer sales.  In addition, some dealers are worried about their ability to succeed as their competitors grow in scale (see Chart IX).  The threat of ever larger competitors capturing an increasing share of a metro or regional car market may make it more difficult to compete without significant size.

“There is a good supply of acquisitions in the U.S.”
Earl Hesterberg, President & CEO
Group 1 Automotive
Fourth Quarter 2019 Earnings Call

I am also aware that some dealers are concerned about recession risk, recently heightened by COVID-19 and February’s stock market volatility.  While 2019 ended with strong consumer sentiment, low unemployment, and record stock prices, 2020 could prove more challenging as a result of the unexpected shock of a potentially global virus.  At this juncture, this is a known unknown.  Until we have more clarity, I continue to expect the buy/sell market to remain active and valuations strong.  The fundamentals of the economy are sound, dealers are well capitalized, and consumers have access to credit.  At this point, I do not see how the virus changes this.

Even if COVID-19 weakens car sales, if there is one thing I have learned about our industry, dealers can manage through any crisis and succeed.  That is why dealerships are in such high demand!  I do not see that changing as a result of a Coronavirus.

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