A 2023 Valuation Perspective on the Auto Dealership Industry

The dealership industry is constantly evolving, and many external factors affect the valuation and profitability of dealerships – fluctuating inventory levels, interest rates, union strikes, new laws and regulations, inflation, and more combine to impact the industry. But generally, the outlook for next year is attractive. The “Chipdemic” supply chain issues of the previous couple years have eased, providing ample inventory in most cases. Dealership acquisition activity has recently slowed a bit in the public sector, but private company acquisitions remain strong, and blue sky value estimates remain high. While challenges persist in the market, leading factors that provide insight on the future of the auto dealerships industry seem to point to a bright 2024. 

Industry Update on Chipdemic/Supply Chain

One of the largest hurdles facing the automotive industry in 2021 and 2022 was the limited supply of vehicles available, driven largely by shortages of semiconductors needed to manufacture critical electronic components. This shortage was termed the ‘Chipdemic,’ and the industry continues to grapple with its effects.

More than 9.5 million vehicles were cut from production in 2021, according to S&P Global, followed by 3 million in 2022. Production losses identifiable as specifically related to the semiconductor shortage fell to 524,000 in the first half of 2023.

The initial normalization of supply is driven by increasing capacity in the semiconductor industry as production has scaled to respond to widespread semiconductor shortages. According to Semiconductors.org, companies have announced more than $200 billion in investment in the build-up to and wake of the passing of the CHIPS Act.

Additionally, the loosening of COVID lockdowns in China after the Chinese Communist Party (CCP) phased out the zero-covid policy in late December 2022 have helped increase production and improve logistics, resulting in a more resilient supply chain. 

However, challenges remain. The chip shortage coincided with a rapid increase in demand for microprocessors. A 2022 analysis from McKinsey estimated that the automotive industry accounts for roughly 20% of all microprocessor demand. New vehicles contain an increasing number of computer-controlled components, and electric vehicles even more so. As the number of microprocessors used per-vehicle increases, so does the amount of ground to be covered by suppliers to meet ballooning demand. 

Industry Conditions and a Deeper Dive on Public Companies

Driven by microchip shortages, anemic inventory levels constituted the dominant industry story of 2021 and 2022. Recently, worries over inventories have since begun to fade. Light vehicle inventory levels totaled 1.1 million units at the end of 2021, near a historic low. Production picked up as 2022 went on, and the year closed with 1.7 million units “on the ground and in transit.” (NADA Data 2022) 

As of November 2023, this number had increased to 2.15 million. (NADA Market Beat) The Auto Inventory/Sales Ratio published by the Bureau of Economic Analysis increased from a low of 0.43 in February of 2022 to 1.13 in October of 2023. However, there remains ground to cover to achieve pre-pandemic inventory levels. During 2019, the Auto Inventory/ Sales Ratio averaged 2.25.

Commensurate with loosening inventory constraints, new vehicle sales have been trending upward. In November of 2023, new light vehicle sales increased year-over-year for the 15th straight month. Total new unit sales in the third quarter of 2023 stood at 3.95 million units, up 16.8% compared to the same period in 2022. (NADA Market Beat) 

Despite this, dealership profitability has exhibited a downward trend. Rising inventory levels and OEM production, which increased despite the UAW strike that impacted the Detroit 3, have put a damper on the pricing power of dealerships. These higher inventory levels coupled with a rising-rate macroeconomic environment have negatively impacted dealership profitability throughout 2023. 

Dealership profitability has taken a hit in the used vehicle department too. Per Cox Automotive, total used vehicle sales in October decreased 3.5% year over year to 3.0 million units. According to public company data, used vehicle gross profit decreased 13% from the same period in the prior year. Profits for publicly traded auto dealerships fell 22% in the third quarter of 2023 against the third quarter of 2022 and are predicted to be down approximately 20-30% per public dealership by the end of the year. (Q3 2023 Haig Report)  

Specifically, we previously saw EBITDA margins for the largest companies in the industry skyrocket during the pandemic. For instance, AutoNation’s EBITDA margin increased from an average of 4.5% from 2010 to 2019 to approximately 8.0% in 2021. AutoNation’s EBITDA margin continued the increasing trend during 2022 when it hit 8.2%. However, we’re starting to see a downward trend in profitability as noted previously. AutoNation’s EBITDA margin for the trailing-twelve months ended September 30, 2023 was approximately 7.1%. Over the same time period, many of the largest companies in the industry exhibited a similar trend.

M&A Trends and Blue-Sky Multiples

Haig Partners is a leading dealership buy-sell advisory firm that publishes an industry report tracking trends in auto retail and their impact on dealership values. The report includes macro-level data for the dealership acquisition market and acquisition multiples for 23 leading automotive franchises across the nation.

According to the most recent Haig report for the third quarter of 2023, at least 385 dealerships changed hands in the first three quarters of 2023, a 12% decrease from the 439 which transacted in the first three-quarters of 2022. At the current level of activity, Haig anticipates that more than 500 dealerships will sell in 2023, compared to an average of 355 stores from 2015-2019. While this number remains solidly above pre-pandemic levels, it represents a likely decrease from record transaction volumes of 707 and 634 dealerships seen in 2021 and 2022 respectively.

This decline in volume was accompanied by a decline in value, with Haig’s estimated average blue sky value declining by 12% from $25.0 million in 2022 to $22.1 million based on LTM earnings as of Q3 2023. The reasons behind this decline are twofold: profits fell in 2023 compared to 2022 and interest rates rose. Rising interest rates hurt the profitability metrics of debt-financed acquisitions and resuscitated floorplan interest expense, which had for a time taken a backseat on many dealer financial statements. The yield on Baa rated corporate bonds as rated by Moody’s has increased from 3.6% in January 2022 to 6.3% in November 2023.  

According to the 2023 Kerrigan Dealer Survey published by Kerrigan Advisors, a premier dealership sell-side advisory firm, more than a quarter of dealers surveyed expected a decrease in the valuation of their dealerships over the next 12 months as of October 2023. This is the highest portion of dealers surveyed to express a negative outlook since the survey’s inception. However, the majority of respondents expect valuations to remain at their 2023 levels into 2024. 

Further, when asked by Kerrigan Advisors whether they expected to sell their dealerships or buy more over the next 12 months, 47% of dealers indicated their intention to add one or more dealerships while only 6% indicated they intended to sell. This differential bodes well for dealership valuations going forward. Kerrigan Advisors attributes this bias toward the buy-side to the war chests dealers have amassed on the heels of three-plus consecutive years of record profits.

US Auto Industry Outlook

Even when faced with a short-term decline in profitability and valuations, the future of the US auto dealership industry looks bright. According to Allied Business Intelligence (ABI) Research, overall vehicle sales will “inch closer to a rebound in 2023.” Despite macroeconomic concerns, the research firm is projecting a 5.1% increase in volume this year to 85.5 million units. North America is expected to grow 6.0%, Europe 6.2% and Asia/Pacific 4.3%. Sales are expected to increase 3.3% in 2024 and reach the previous high of more than 90 million units in 2025.

The longer-term outlook for the auto industry is also extremely positive, as the industry is undergoing a major transformation, driven by factors such as the rise of electric vehicles, the growth of autonomous driving, and the increasing popularity of ride-hailing services.

• The rise of electric vehicles is one of the most significant trends in the auto industry. Electric vehicles offer a number of advantages over gasoline-powered cars, including lower emissions, lower operating costs and improved performance. In addition, clean vehicle credits are financially incentivizing consumers to consider an EV. As a result, electric vehicles are becoming increasingly popular, and the global market for electric vehicles is expected to grow significantly in the coming years.
• The growth of advanced driver assistance systems (ADAS) and autonomous driving (AD) is another major trend that is expected to have a significant impact on the auto industry. According to McKinsey & Company, the global market for ADAS and AD is expected to grow from $22.4 billion in 2020 to $120.7 billion by 2027. North America is expected to be the largest market for ADAS and AD, followed by Europe and Asia Pacific.
• Additionally, the increasing popularity of ride-hailing services is having a significant impression on the auto industry. Ride-hailing services offer a convenient and affordable alternative to owning a car. The popularity of the model is leading suppliers to think about new business models, such as subscription-based car ownership and car sharing. While this could have a negative impact on new car sales, demand in the longer term will be supported by an expansion of the ride hailing market, increased car sharing, and government mandates to upgrade ride-hailing fleets to EVs and other environment-friendly options.
  
  

Looking at the short-term scenario, the following are the factors which will influence the auto industry significantly in 2024.

• Both new and used car prices will remain high in 2024. Continued high prices are all but guaranteed. Automakers are not likely to pass on an opportunity for “price adjustments.” Despite consumer demands for more affordable options, OEMs continue to produce higher priced SUVs and trucks. A significant percentage of consumers feel that they cannot afford new cars. Manufacturers are increasingly relying on fewer buyers to pay higher prices in order to turn a profit.
• The United Auto Workers (UAW) strike spanned from September 2023 through October 2023. The strike ended with tentative labor contracts being reached between the union and auto manufacturers. While there has been little impact to vehicle demand from the UAW strike, evident by recent months outperforming expectations, the strike may impact future vehicle supply and pricing.
• Interest rates will stay high. Cash will remain king in 2024. As of November 2023, the average new car loan APR was 7.4% as reported by Edmunds. Used car loans are even more expensive, with the average APR at 11.6%. The Federal Reserve has stated that rates will remain near current levels through at least the first half of 2024. As such, auto loan interest rates are forecasted to remain high in 2024.
• With 2024 being an election year in the United States, the auto industry is bracing for potential policy shifts and market reactions that often accompany electoral cycles, adding yet another layer of unpredictability to an already uncertain landscape. 
  
  

The above factors combine to make the outlook for the auto industry in 2024 particularly challenging to forecast.

US Light Vehicle Sales Outlook

According to GlobalData, the forecast for 2023 for light vehicle sales is at 15.4 million units. With the improvement of supply constraints and stabilization of demand, GlobalData has forecasted 2024 to hit 16.1 million units.  

Looking Forward

Auto dealerships, like other businesses, are attempting to navigate these emerging trends to improve value delivered to shareholders and customers. The unprecedented increase in dealership profits seen on the heels of the COVID pandemic has reversed slightly and dealership values have followed suit. Whether a normalizing supply chain and industry trends including electric vehicles and the growth of driver assistance systems will be enough to sustain post-pandemic profitability remains to be seen, especially as costs continue to increase and interest rates remain high.

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