Reviewing earnings calls from executives of the six publicly traded auto dealers, new vehicle gross profit declined as inventory availability improved, though the decline in profitability was less than anticipated. While unit-level profitability is anticipated to continue to decline, there are signs of strength in consumer demand. Despite affordability issues, the market is anticipated to remain structurally above pre-pandemic levels.

Improved new vehicle availability has led to declines in used vehicle prices as consumers are no longer forced to substitute from new to used. This new-used imbalance has so far outweighed what would be tailwinds to used vehicle profitability. Specifically, affordability has replaced supply constraints as the reason consumers are substituting for used vehicles, but constrained new vehicle supply in the past three years means the supply is much smaller for the desirable 1-4-year used segment. The reduced supply has a trickle-down effect, leading to an older average age of vehicles throughout the country, which points to pent-up demand for vehicles and fixed operations to service these older vehicles.

Let’s flesh out the major themes from the Q2 2023 Public Auto Earnings Calls:

Theme 1: New Vehicle GPUs Moderated More Slowly Than Anticipated

As new vehicle inventories improved coming out of the supply chain issues, volumes were anticipated to increase, offset by declining profitability per unit. However, the decline in profitability has not happened as quickly as some expected due to pent-up demand. Public auto dealers also noted a fair amount of runway due to pent-up demand as presold vehicles and the number of vehicles sold at MSRP are still high, and lease penetration and incentives are still below historical levels.

• “Light vehicle sales remain below what most of us who’ve been in the business a long time would consider trend. Where industry incentives and lease penetration, even though they both have been increasing as late, they’re still significantly below pre-pandemic levels, which I think just to give you an indication, OEMs still have a lot of additional tools to help spur demand if it’s needed in the marketplace. […] Gross PVRs as expected, continue to mitigate, yet remains robust. […] Front-end margins have been more resilient than most of us were expecting heading into the year. Now I expect margins will continue to moderate partly to maintain current demand in this higher monthly payment environment and partly as inventory levels continue to increase and fewer vehicles are being sold at MSRP. However, I do not expect margins to return to pre-pandemic levels for the foreseeable future based on higher average selling prices of vehicles and continued lower industry inventory levels.”
  – Michael Manley, CEO, AutoNation
• “Thus far in 2023, GPUs for new vehicles have come down approximately $100 per month, half of our original expectations. We remain focused on growth and profitability, and we look to gain further efficiencies across our businesses. […] I think in terms of looking forward on where we see GPUs going, I think we still are in the camp that GPUs will normalize. We still believe it’s somewhere between $300 and $500 above pre-COVID levels.”
  – Bryan DeBoer, President and CEO, Lithia Motors
• “Most of the presold vehicles will be sold at or very close to MSRP. And you think about our luxury and import, almost 50% of the volume come from Lexus, Mercedes, Toyota, and Honda. All those brands, we have a low day supply. So, you could imagine that a lot of those vehicles are presold in those lines, which are going to garner high PVRs. […] To your point on the domestics, we’re back to what I would call a normal day supply of domestic vehicles. […] We’re not going back to ’19 levels [of new vehicle GPU].”
  – David Hult, CEO, Asbury Automotive Group
• “The industry continued to see improvement in new vehicle production and inventory levels which results in incremental new vehicle sales volume and lower new vehicle gross profit per unit sequentially as expected. This decline in new vehicle GPUs should continue as we progress through the second half of 2023 and into 2024, but we continue to believe that the new normal of new vehicle GPU will remain structurally higher than it was pre-pandemic.”
  – David Smith, CEO, Sonic Automotive
• “Looking at the presales in the US, I mean to us, that indicates a pretty healthy, strong consumer. Looking at the aftersales pull-through, we see evidence of a pretty strong consumer. We’re seeing a little pressure in F&I, but it’s just a little bit, honestly, I mean it’s $100. I mean — so from a consumer perspective, we see good things there. And I don’t know if that will change.”
  – Daryl Kenningham, President and CEO, Group 1 Automotive

Theme 2: Days’ Supply Influenced by Brand, Model, and Potential Labor Strikes

There continues to be significant dispersion in days’s supply by brand, as volume import brands have the lowest supply and domestics have the highest. When asked about a pending UAW strike, executives pointed out that domestics had the highest day supply, and the strike could ultimately be positive toward GPUs.

• “As is the case with the overall industry, we have a wide dispersion of inventory levels by brand and model. In core brands are generally below the company average, domestic brands generally above and premium luxury generally in line with the average. The overall new vehicle market remained healthy during the quarter as almost 40% of our vehicles were sold at MSRP, which continues to be far higher than pre-pandemic levels. This is down from about 45% in Q1.”
  – Joe Lower, CFO, AutoNation
• “Consistent with our comments on inventory last quarter, our domestic brands have improved slightly and import brands have remained very constrained. Approximately, 28% of our US business is Toyota and Lexus, which continues to be very tight at a combined five-day supply.”
  – Daryl Kenningham, President and CEO, Group 1 Automotive
• “Whether that is a strike or prolonged strike, or they get to an agreement beforehand, I don’t know. But what I can tell you is if you look at the inventory development, the biggest growth in inventory that we’ve had is in our domestic. That to me gives me a level of comfort. […]We still only have 43 days of the domestic. I have to say embarrassingly in my time, we were up at 130. So, when we talk about build, I think we still have to remind ourselves and ground ourselves that particularly for the domestics, high levels of inventory, spot deliveries is what most of the customers are used to and expect in those businesses. So yes, we are talking about a build, but we’re only at 43 days.”
  – Michael Manley, CEO, AutoNation
• “That UAW strike, it could help stabilize our margins, which is quite nice. It may be part of the reason why I may hedge a little bit of that $100 declines. If we do get that strike with certain manufacturers, it could be a nice thing to help stabilize those GPUs for a little bit longer.”
  – Bryan DeBoer, President and CEO, Lithia Motors
• “The inventory question is hard to answer only because when you look at an average day supply, the split on that goes from a six-day supply on a mainline import and then an 83-day supply on a large domestic. And so what it is, is the gives and the takes between all the Ms that make an average. But what we do know is the lower priced vehicles that are affordable for consumers and the affordability is a big piece of this that are on the ground are turning faster than heavy content vehicles and more expensive vehicles. […] And so the GPUs kind of follow the general trends that you’re seeing based on supply and demand. And so more inventory generally means more discounting and we’re kind of watching it out.”
  – Chris Holzshu, EVP & COO, Lithia Motors

Theme 3: Volatile Used Vehicle Prices Declined Since March

When new vehicle production declined, consumers were forced to turn to used vehicles, causing used vehicle prices to appreciate at a faster rate than new vehicles. The unwinding of this unsustainable price difference between new and used vehicles is the primary reason for the price decline. However, used vehicle prices remain volatile, requiring either conservative purchasing or exposure to sharp declines in market values. Since vehicle affordability is a key concern for many buyers, used vehicle prices have declined to balance higher payments from rising interest rates.

• “Same-store used vehicle revenues were down 15.8%, driven by unit volumes declining 11.6% and ASPs decreasing 4.7%. The recent decline in used car prices is a result of higher interest rates and gradual pace of new vehicle inventory improving.”
  – Chris Holzshu, EVP & COO, Lithia Motors
• “We know everybody is trying to get zero to four-year used vehicles, and that’s still going to be tight, because they have less trades on vehicles over new vehicle sales over the last say, 18 months. They were all fishing in the zero to four times. And we had a number of lease returns that didn’t come back during that period due to customers buying out or extending leases. So, what I see is probably the cost of sales going down in the market. But on the other hand, I think we can maintain our grosses, because we’re going to stay in the zero to four-year timeframe, we’ve done that in the past, and hopefully, when we look at the opportunity here, we’ll get some cars coming off lease, which before obviously, we’re going to customers who are buying those.”
  – Roger Penske, Chairman and CEO, Penske Automotive
• “In the used vehicle business, wholesale auction prices for three-year-old vehicles decreased 6% in the second quarter, unwinding the surprise increase we saw in the first quarter. And this is important. July month-to-date, three-year-old wholesale prices are down nearly 4%, consistent with our expectations for continued price normalization in the third and fourth quarters, which will ultimately benefit consumer affordability and demand for used vehicles once retail pricing follows the wholesale trend in the same directions. […] We mentioned it earlier. I mean it was from all accounts a historic drop in valuations in the used car market. So we think strategically, it’s really smart to keep that inventory tight. And as Jeff said, maybe miss a few retail deals until that market starts to flatten out more consistently and then we can crank up the volume.”
  – David Smith, CEO, Sonic Automotive
• “New car inventory across the board from everybody’s announcements is going up from a day supply perspective. No sales in the auction lanes are real high, north of 50% right now, which is a good sign that inventory is building and prices are going to come down. So there’s going to be more volume to buy [with] the rental car companies pretty much now out of the lanes from buying cars, and that’s what really caused a big issue in March for us and for the industry.”
  – Jeff Dyke, President, Sonic Automotive

Theme 4: Opportunities and Challenges from Aging Vehicles

With three years of depressed new vehicle volumes, there are both opportunities and challenges for auto dealerships. Older vehicles portend pent-up demand for vehicle sales and require more maintenance. Lower sales velocity for new vehicles also reduced trade-in opportunities — a key sourcing mechanism for used vehicle sales.

• “There obviously continues to be mixed economic signals in the overall economy. But from our point of view, the supply and demand equation, even though it is moderating, we think, has remained favorable for the business. And last quarter, I said that we thought the consumer in no way tapped out, and we still feel that’s the case for sure. Now notwithstanding the fact that higher interest rates are impacting affordability, lower unit sales over the past few years have contributed to pent-up demand, which, as we see inventory levels improve and some mitigation on that transaction price continue to convert to sales in the marketplace. And the aging vehicle part, which is now about 12.5 years as well as positive household formation, I think, are additional favorable dynamics for the business. And these factors, I think, will continue to be a benefit for new and used vehicle sales going forward.”
  – Michael Manley, CEO, AutoNation
• “The US car park lost approximately 8 million units during their production declines in the COVID pandemic, which will provide years of demand tailwinds for used vehicle inventory. This scenario again highlights the benefits of being a top of funnel new car dealer were accessed to customer trades and off-lease products from our partner OEMs is a massive differentiator as it represents over 75% of our used vehicle sales.”
  – Chris Holzshu, EVP & COO, Lithia Motors
• “We are optimistic about the future of automotive retail. We operate in an environment where the average age of our car is 12.5 years, the highest it’s ever been. While SAAR levels have been trending higher, they are still well below historical levels. The combination of older cars, complexity of new cars and the transition to EVs enables consistent growth within our parts and service business.”
  – David Hult, CEO, Asbury Automotive Group
• “I think the game is turning to throughput again here in the future. And a lot of our focus and efforts will be towards that. And we still see a lot of demand out there. Carpark is still really aged. There’s still a lot of repairs to be done on vehicles that have been — that are older units, older vehicles. And — so I believe that there’s still — the outlook is for parts and service is still bright, it’s really bright, still opportunistic.”
  – Daryl Kenningham, President and CEO, Group 1 Automotive

Tidbits of Note

As usual, we found a few other tidbits of interest for our auto dealer clients, which aren’t included as trends because they were only mentioned by one of the public companies. This quarter, we note comments by Lithia about stock compensation, AutoNation about dealership size, and Asbury about EV RO’s.

Stock Compensation

Lithia was asked about its GM incentive program — Lithia Partners Group, or “LPG” — and its impact on the company. Lithia CEO Bryan DeBoer noted that GMs in the LPG get twice as much ownership in Lithia stock, along with other perks incentivizing the GMs to manage the store as if they owned it.

We’ve seen numerous cases of clients giving/selling equity interests ranging from 5-25%, which is similar but also comes with fewer issues when a GM leaves a privately held store, frequently necessitating a valuation of their ownership interest.

Dealership Size

When discussing fixed operations capacity, AutoNation CEO Michael Manley noted that OEMs have oversized their dealerships for many years. While OEMs and dealers might wish they could snap their fingers and fundamentally change the size and locations of dealerships as they stand today in a post-COVID environment, the switching costs are too high for this to occur en masse.

The industry appears to be generally consolidating, but this is more about the number of owners rather than a decline in the number of dealerships.

Aside from dealers monetizing their land in growing metropolitan areas, there likely won’t be a material change to where dealerships are located and how big they are. Smaller dealerships would reduce costs and might enable finding more convenient locations to increase fixed operations market share.

EV Repair Orders

With the transition to electric vehicles, proponents have consistently pointed to lower maintenance costs offsetting higher upfront vehicle purchase costs, in addition to environmental benefits. While strides have been made to reduce the upfront cost, the anticipated maintenance expense decline may not have a dollar-for-dollar adverse impact on auto dealers.

Asbury SVP Daniel Clara indicated that the average repair order of BEVs was 1.5x that of ICE vehicles.

If auto dealers can price these repairs more advantageously and capture greater market share with customers trusting technicians specially trained for EVs, the future decline in this part of the business may have been overstated.

Conclusion

At Mercer Capital, we follow the auto industry closely to stay current with trends in the marketplace. These give insight into the market for a private dealership, which informs our valuation engagements. To understand how the above themes may impact your business, contact a professional at Mercer Capital to discuss your needs in confidence.