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.
- “So we don’t want 60-day supply inventory. We don’t need more 45-day supply inventory. They could just get it back to the 20 and 30-day supply you got great demand, great margin, and it sets up ’22 and really ’23 for just to be fantastic years for the industry.
– David Smith, CEO, Sonic Automotive
- “The OEMs have become more sophisticated in that regard. And they understand that too much inventory is bad for us and we’re not going to take it. And it’s bad for them too. And that lesson is really being driven home right now to the OEMs as to the cost of excess inventory. The distribution channels in both the US and UK have been overstuffed for a decade or more. And now that they get leaned out, you can see what it does for the OEM profits also. It’s much better for them. And so I think we’re going to be in a much better position going forward.”
–Earl Hesterberg, President and CEO, Group 1 Automotive
- “I have to believe that given all the learning through the pandemic and supply and demand dynamics that we’ve recently seen and the clear messages coming from the manufacturers, we will not return to the excessively high inventory levels that depressed new vehicle margins for both the dealers and the OEMs. […] And the levels of profitability for both OEMs and dealers clearly show the benefits of selling vehicles at MSRP. And what a concept, right, selling at MSRP.”
–Michael Manley, CEO, AutoNation
- “When you look at the floor plan support, you look at customer support, and you look at the incentives that are being paid over the traditional years where we had normal business, the OEMs are digging deep in their pocket. Now they’ve seen a real benefit by backing that off. In fact, I think that’s helping them look rationally down the road that will help them find the R&D that’s going to be necessary when we look at electrification. So hopefully, they got a taste of that. And that will be a slow return and they’ll keep the day supply in the 30 to 45 days and we won’t obviously be where we are today in single-digits. But I think we can manage that carefully brand by brand.”
–Roger Penske, Chairman & CEO, Penske Automotive Group
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.
- “Well, I would hope no one would ever go over 50 days again. And, of course, historically the domestic has always had well over that because of these — the big variation on the build combinations of full-size trucks and things like that. But for decades Toyota dealers have operated well below 30 days and never missed that much business as far as I could tell. So I think most brands can operate in 30 days to 40 days. And hopefully there will be a corporate memory that the OEMs also can see this benefit and try to manage that way as we go forward. However, any time these large auto companies start fighting for market share that’s when the discipline can erode.”
– Earl Hesterberg, President and CEO, Group 1 Automotive
- “It’s a competitive world and you never know what someone is going to do to try and gain market share and grow their business. I think everyone’s learned from the concept that we can be effective with a lower days supply and everyone can benefit from that. Does that mean we’ll stabilize at a 35, 40 days supply compared to a 65 or 70? I think it’s too early to tell.”
–David Hult, CEO, Asbury Automotive Group
- “Total vehicle GPUs returning to pre -pandemic levels. […] Every day it does seem like the window for increased elevated margins are probably there for longer than we all would like or our consumers would like, but it may be that they don’t return to some normalized level”
– Bryan DeBoer, President and CEO, Lithia Motors
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.
- “It’s hard to tell but we see the values starting in November, December, have adjusted meaning that they’re not growing exponentially as they were before. And until the inventory levels, our belief is until the inventory levels for new cars somewhat stabilize, the used car valuation is going to remain where it is right now. And I don’t — we don’t believe that when there is a correction that it will be an immediate correction. It’s going to be a gradual correction. So — but we do believe that is going to be dependent on the new DSI.”
– Daniel Clara, SVP and CFO, Asbury Automotive Group
- “We’re sitting at a 36-days supply [on used vehicle inventory…] What you worry about is the rest of the market out there that might have a 60, 80, 90-day supply, they’re still sitting on cars that they paid at the height of the market, they’re going to have issues. […] It’s the price point, right? That’s pushing demand up for new cars really because the used car price points are so high and that’s got to give. And it’s going to give. I mean that’s going to happen. Used cars are not — like I said earlier, are not going to continue to appreciate. We do believe we’re starting to see the depreciation cycle start, if the last six weeks are any indication of that.”
–Jeff Dyke, President, Sonic Automotive
- “The used market obviously is super dynamic. We’re able to keep the inventories at the level they are because of our — we changed our sourcing model. And the good thing about the PRUs is, we manage our inventory very tightly. So, any changes in the pricing environment we can react very quickly. I don’t know when it’s going to change. I feel like it’s going to change at some point this year, but I don’t know when.”
– Daryl Kenningham, President, U.S. and Brazilian Operations,
Group 1 Automotive
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.
- “We’ve seen a number of comments about vehicles being sold above MSRP, quoting the potential adverse impacts on brands and customers, which I understand. And by the way, last year, less than 2% of all the new vehicles sold by AutoNation were above MSRP. But this discussion on MSRP branded customers actually also adds to my optimism regarding new vehicle margins going forward. Because I think it’s equally clear that significant discounting and high incentives can also damage a brand, which is another reason for our industry to balance appropriately supply and demand, and another reason why we may expect higher new vehicle margins than we have historically seen pre-COVID. […] I think where the issue is where you’ve got a short-term temporary disruption and your supply and demand curve in, what I would call, general market, mass market vehicles, where there is no history in these mass market vehicles of used prices going significantly above for a long period of time against new vehicles. And I think that is where you have to be incredibly careful.”
– Michael Manley, CEO, AutoNation
- “We’re pressing very hard for them not to bring inventory levels back to pre-pandemic levels. And so margins are going to stay high. The margins prior to the pandemic are low. We should be selling cars at MSRP. I mean this industry needs to get away from doing all the negotiating it’s a hell of a lot less complex, much easier, and it brings the right value for the vehicle. […] I just don’t see margins coming back going back to pre-pandemic levels ever.”
–Jeff Dyke, President, Sonic Automotive
- “However, our inventories are still tight and led to a majority of units being presold. As a reminder, our focus is on driving long-term relationships with our customers. We direct our stores to sell at MSRP. It helps to create the kind of sticky relationships that feeds our segment-leading aftersales performance. We realized it cost us some SG&A leverage in the short term. But for us, it’s much more important to drive retention in the strongest part of our business which is aftersales.”
–Daryl Kenningham, President, U.S. and Brazilian Operations,
Group 1 Automotive
- “Our stores make those decisions in the field. And they do that based off their supply and what their competitors are doing. So yes, we do have some stores that are charging over MSRP. We don’t have specific numbers because we don’t specifically track it because we allow our network to make the decisions close as to what their customer base is and what the supply and demand is in that local market.”
–Bryan DeBoer, President and CEO, Lithia Motors
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.