By Ryan Kerrigan, Managing Director, Kerrigan Advisors
Though SAAR remains relatively flat in recent years (see Chart 1), the financial health of the largest auto retailers could not be stronger. Multiple public dealership groups are posting record revenue and profits through the first half of 2019. These results are driven by strong execution and strategic tilts towards the most profitable elements of the business model, namely F&I, used cars, and fixed operations. The Kerrigan Index™, the only index tracking the performance of the seven publicly-traded auto retailers is up an incredible 37% as of July 31, 2019 (see Chart 2). This recent performance is a great reminder of the strength and resilience of auto retail’s business model, and its ability to adapt to changing market conditions.
Since SAAR peaked in 2015, auto retail has been in the doldrums, managing in a new paradigm of no growth. Predictably, new-car margins have compressed significantly, and bottom lines have come under pressure. This period was aptly characterized as a plateau, but a plateau with a “hell of a view” as noted by John Mendel, former head of American Honda Motor Company. Dealers reliant on new-car revenue and gross margin got squeezed. Many dealers aptly refocused on higher-margin business lines, namely used vehicle sales, fixed operations, and F&I penetration. Only 9.0% of the average dealers’ gross profit stems from its new car department (see Chart 3). Now, a few years into this new paradigm, we are seeing industry profits grow, even as the headlines continue to discuss shrinking SAAR numbers.
Revenue and Profits are UP
Even in a world of falling new-car volume, average dealership revenue is up 3.9% through May 2019, with gross profits up 4.2%, and profits up 1.4%. The profit numbers are likely understated due to add-backs and adjustments applicable to most private dealerships. While new-car volume is down 2.8%, dealers are driving more revenue through their new-car departments through a better mix of pricing, resulting in revenue increasing by 2.0%. And, used car revenue and fixed operations revenue are up 5.6% and 7.2%, respectively, underlining the strong environment for the auto retailers.
In looking at the publics, the second quarter 2019 numbers are even more compelling (see Chart 4). AutoNation posted record profitability, up 3.5%, crediting used cars, fixed operations, and F&I for the gains, which resulted in a record earnings-per-share from continuing operations. Asbury Automotive Group’s second-quarter revenue and earnings rose 4.6% and 7.5%, respectively.
Again, the trifecta of used vehicles, fixed operations, and F&I drove the strong performance. 86% of Asbury’s gross margin is derived from those three segments, though they only comprise 47% of revenue. Backing out unusual expenses tied to hail and extreme weather damage, Group 1 Automotive’s revenue was up 2.1% and earnings up 3.9% in the second quarter, driven by a 10% increase in fixed operations, and a record of $1,821 in F&I gross profit per vehicle. Lithia Motors’ revenue rose 4.0%, while earnings were up 2.0%, again citing very similar drivers of improved performance.
And, Sonic Automotive announced a revenue increase of 4.3% and a tremendous earnings increase of 57.3%, with much of the credit going to Sonic’s standalone used car stores, EchoPark. Only Penske Automotive Group reported a decline in earnings in the second quarter, which was largely attributed to their significant footprint in the UK, which is working through Brexit uncertainty. These remarkable results are being announced at the same time as industry headlines are negatively reporting that “U.S. sales may fall for the seventh straight month.”
Market Caps Are Surging
The strength of the public auto retailers’ financial performance is reflected nicely in their recent stock prices, with The Kerrigan Index up 37% in the first seven months of the year, as previously noted, adding over $8.1 billion in value in that period of time (see Chart 5). During the same period, the S&P 500 Index is up a strong 19%, but six of the seven component stocks of The Kerrigan Index are tracking well ahead of the S&P’s gains. Sonic is up a stunning 102%, followed by Lithia (+70%), and Group 1 (59%), while AutoNation, Asbury, and CarMax all up over 30% in the first seven months of 2019 (see Chart 6).
It is worth repeating that stock prices reflect the consensus on future earnings of a given company. The strong gains in the stock market show the consensus that the earnings outlook for auto retail has improved considerably, despite several economic analysts’ predictions that we are overdue for a macro-economic correction.
This seeming contradiction between booming auto retail stock prices and the anticipation of a cyclical correction is a testament to the diversified and countercyclical nature of the auto retail business model. While the economy flows through cycles, the flexible cost structure of auto retail allows dealers to shift, adapt, and stay profitable. For example, during the most recent recession, dealers decreased expenses and saw their net to sales improve 220% in 2009 as compared to 2008. (see Chart 7). Profitability, both current and future, is what is driving these stocks upward.
And What About Disruption?
Anyone in auto retail cannot help but notice the regular flow of articles and dire predictions about the tumultuous change just around the corner for auto retail. There are regular predictions on how autonomy, connected cars, electric vehicles, and shared vehicles will significantly impact the current business model, as well as the added threats of manufacturers attempting to go direct-to-consumer as Tesla has.
Here again, it is worth pointing out that the stock market reflects the best, most-informed consensus on the future earnings of companies. Auto retail’s resurgent stock prices indicate that the current consensus is that disruptors are unlikely to impact earnings anytime soon. The challenges brought on by technology are either too far off, or too unknown, to dampen stock prices. While the stock market is not perfect, it does represent the best collective guess on future earnings, and the earnings outlook for dealers today is stronger than it was one year ago.
Last year, Kerrigan Advisors was one of the few voices predicting profitability in auto retail would improve in 2019 irrespective of SAAR. It turns out we were right, despite all of the negative industry chatter. Dealers are very adaptive to shifts in local market conditions, can bring down variable expense quickly when required, and have compelling, high-margin alternative business lines. In light of these factors, good operators can and will adjust to the current SAAR and grow profits. 2019’s earnings performance shows that is precisely what dealers are doing.
About the Author
Ryan Kerrigan is managing director of Kerrigan Advisors, the leading buy/sell advisor to auto dealers in the US. Ryan oversees capital raising and private equity/family office investor relations, in addition to transaction and consulting work. He started his career at McKinsey & Company as a management consultant, advising Fortune 500 companies on growth strategies, organizational issues, and business valuation. Ryan also has extensive experience in auto retail, having been a general manager of his family’s dealership. EMAIL: firstname.lastname@example.org