There continues to be no end in sight for new vehicle supply constraints. In past posts we have noted how executives keep kicking the can down the road, guessing things will normalize in 6 months or so, which they’ve been saying for the past twelve months. Group 1’s management team was refreshingly honest on the situation as detailed in the quote below.

“I have been unable to predict on [when inventories normalize] with any accuracy at all. I continue to be shocked. And every month seems to delay the recovery another month. Clearly, no one is building inventory still. […] It seems that there are some issues beyond chips as well now with COVID interruptions and shipping interruptions […] I can’t even keep track of all the stated reasons. But it would certainly seem the first half of the year is going to remain with severe new vehicle inventory shortages. I don’t know what will happen in the second half of the year.” – Earl Hesterberg, CEO of Group 1 Automotive

Inventory shortages are at the forefront of many of this quarter’s themes. While dealers across the country are looking to increase their new vehicle inventories, used vehicles are in greater supply. Numerous executives noted they are carefully managing this inventory to avoid getting burned on currently elevated prices. All the publics (except Lithia) explicitly mentioned a hope that inventories would increase to a new normal, that is below pre-pandemic inventory levels. Executives also seem to generally believe that GPUs will normalize with inventories, though a push for market share by industry participants may further shrink GPUs once inventory is available.

On February 15, Edmunds released research indicating 82% of car shoppers paid above sticker price in January. While there have been reports of dealers charging above the manufacturer’s suggested retail price (“MSRP”) since mid-2021, the practice has proliferated and analysts sought comment on the topic this quarter, which was generally denounced for various reasons, again with Lithia being the exception.

M&A was not as big of a topic of conversation as in prior calls, though it does still come up. The current M&A market for dealerships is similar to the market for the vehicles they sell: values are elevated above historical norms. As a result, dealer principals may be more interested in testing the waters on what they could get for their dealership. Most executives and dealer principals acknowledge that recent strength in new vehicle grosses should normalize whenever inventories normalize (we’re still waiting). Still, if dealers think the price is right, they may be willing to sell if they can get anywhere near a “normal” multiple on these heightened profits.

Private dealers testing the waters on the Blue Sky for their dealership reminds me of Zillow’s “Make Me Move” feature that they recently discontinued. Homeowners on the fence about selling used to be able to post a high price, and if they got traction, they may decide to sell, avoiding the potential penalty of having your home listed for a significant amount of time, which leads to price concessions or actually discourages would-be buyers assuming something “must be wrong” with the house. Bringing it back to vehicles, I recently tested what offer I’d get on my 11-year old vehicle and was pleasantly surprised as it was considerably above its pre-pandemic value.

When it comes to M&A for the public automotive retailers, they continue to focus on brand and geographic fit. An interesting nugget came from Sonic that may be interesting to smaller market dealers. While 2021 was the year of the mega-deal, Sonic noted its large RFJ acquisition (which was one of the mega-deals) primarily operates in smaller markets. While the company previously would not have been interested in buying such dealerships, the success they’ve seen thus far means they are open to more tuck-in acquisitions of dealerships in smaller markets, a welcome development for such dealer principals.

A couple of other interesting pieces didn’t quite make their own theme. Penske threw cold water on the adoption of EVs, noting that 98% of its sales have been ICE over the past three years, and while OEMs have committed to more EV models, Penske believes it will take “longer than people expect” for widespread adoption, largely due to costs of EVs. Regarding discussions about direct-to-consumer sales, he also called attention paid to startups like Rivian “overblown.” Penske also holds more used vehicle inventory than Asbury, AutoNation, Group 1, and Sonic.

Lithia also holds more used vehicle inventories than its peers and as noted previously, and doesn’t have a problem with charging over MSRP. Curiously, its executives also began positioning the company for an environment without franchise laws as it suggests the industry could move towards an agency model with its manufacturers by 2035 (see page 18 of its investor presentation).

Theme 1: While dealers are looking forward to more normal inventory levels, they believe there is something to be learned from the heightened profits in the last year: auto dealers are hoping “normalized” inventory levels will be considerably below pre-pandemic levels.

Theme 2: Whenever vehicle inventories normalize, vehicle profitability is expected to normalize as well, though some executives cautioned an attempt to grab market share could further depress heightened GPUs. Notably, Lithia’s base case assumes vehicle profitability fully returns to pre-pandemic levels.

Theme 3: Used vehicle prices have runup even as compared to the price increase of new vehicles. Public auto dealers are trying to avoid being left holding the bag as the company holding too much used vehicle inventory when the music stops.

Theme 4: In the high-priced environment, more dealers are charging above MSRP or requiring customers to buy add-ons in order to get the vehicles they want. OEMs generally denounce the practice, as did some of the public auto dealers. Generally, the practice is viewed to leave consumers not trusting the dealer community.

Conclusion

At Mercer Capital, we follow the auto industry closely in order to stay current with trends in the marketplace. These give insight into the market that may exist for a private dealership which informs our valuation engagements. To understand how the above themes may or may not impact your business, contact a professional at Mercer Capital to discuss your needs in confidence.