My colleague, Travis Harms, published an article on his Family Business Director Blog entitled “Looking Back to Look Forward” earlier this month making observations from companies that survived the Great Recession. Travis analyzed data from 554 operating companies for two-year periods before the Great Recession (2006 and 2007), two years during the Great Recession (2008 and 2009) and two years following the Great Recession (2010 and 2011). Travis concluded five observations from the data analyzed:
- Operating leverage can be managed
- Working capital really is a source of cash during a downturn
- Companies become more disciplined investors
- Borrowers reduce debt levels
- Dividends are much less affected than share buybacks
Operating Leverage Can be Managed
The data from Travis’ study illustrated that the companies experienced a 15.6% revenue decline in 2009, but EBITDA margin only fell slightly by 0.5%. How was that possible? Companies were able to mitigate the decline in revenue from falling to the bottom line by making conscious efforts to reduce expenses. The Auto Dealer revenue model consists of new vehicle sales, used vehicle sales, parts and service, and finance and insurance. As we’ve written about and discussed in this space, new vehicle sales as illustrated by SAAR, have fluctuated with the economic cycle. In times of declining new vehicle sales, successful dealerships have shifted focus to their other profit sources. Additionally, dealerships have focused internally on managing and reducing internal operating costs. In 2019, light vehicle sales in declined in the US, and industry executives were highlighting other aspects of their business model mitigating declining volumes as indicated by SAAR before the spread of the virus. Dealerships already had an eye on monitoring costs from sluggish performance times in the past, and managers can lean on their experience from the Great Recession in terms of finding which costs can be cut.
Working Capital Really is a Source of Cash During a Downturn
The companies in Travis’ sample reduced working capital by $20.8 billion to mitigate lost revenues of $175 billion. Those in the auto dealer industry know that working capital is dictated and monitored by the manufacturer with requirements usually listed on the front page of the dealer financial statement. If auto dealers aren’t afforded the luxury of reducing their working capital, how can it become a source of cash during a downturn? Throughout the last month, one of the mantras that I’ve heard repeatedly in the auto dealer space is that dealers need to maximize any source of revenue or equity at the dealership. One such place is the inventory – auto dealers should become acutely aware of the economics of every unit on their lot. Most auto dealers obtain floor plan financing for all of their new vehicles and at least a portion of their used vehicles. However, not all auto dealers finance their used vehicles or the entire portion that their lender will allow. During these economic times, auto dealers should consider contacting their lenders to discuss the financing terms on their used vehicles that have yet to be financed. For example, if a dealer currently finances 50% of the value of their used vehicles, but the lender will allow 80%, why not finance the additional 30% to create cash flow?
When auto dealers are scouring their lot for used vehicles that aren’t being financed, another strategy they should consider is expediting the sale of aging used vehicles that are not selling in the retail market. Opting to move these vehicles through the wholesale or auction market can turn idle inventory into cash flow, which is key for auto dealers in the coming months.
Companies Become More Disciplined Investors
The figures from Travis’ study concluded that total investment spending from the companies in the sample declined nearly 80% during the analyzed period. Auto dealers have image and real estate upgrade requirements from the manufacturers. As we’ve previously covered in this space, the quality/condition of real estate is one of the key value drivers in the valuation of a particular store. Successful dealerships have already been maintaining their real estate and image requirements, so they should hopefully be able to minimize their capital expenditures over the remainder of 2020. Manufacturers are also likely to be less forceful in compelling dealers to upgrade their facilities until the economic environment improves. Adding different brands/rooftops is another way an auto dealer can add value, giving consumers more options and spreading overhead costs over more sales. Dealers are less likely to make these investments during economic uncertainty, though it may also entice some local competitors to seek to exit the business, which could provide an opportunity given a mutually beneficial circumstance.
Conclusions
Auto dealers are a resilient, adaptable group by nature. It’s one of the reasons many have been able to survive economic hardships or sluggish industry conditions in the past. While we haven’t witnessed the unique totality of the conditions that are present today, auto dealers can adopt some of the principles from the Great Recession to try and mitigate the challenges during the survival mode portion that we currently face.
