Is now the right time to invest in auto retailing?

Auto Dealer

The Automotive Retail team at Truist Securities advises a variety of dealerships across the country on buying, selling, and capitalizing their dealerships. JT Taylor, head of Automotive Retail at Truist Securities, shares his perspective on how buyers are viewing opportunities in the retail dealership business. 

The auto retailing sector has been booming over the past two years, but questions about extending current dealership profit levels into the future combined with current economic headwinds make forecasting challenging. For now, the auto retailing industry holds the interest of consolidators and investors looking for promising dealerships to buy.

Investors remain bullish on auto retailing.

As investors look to buy dealerships, access to cost-efficient debt to fund acquisitions and a thoughtful financial partner like Truist are only the start.  Of principal interest to investors is whether current operating conditions will continue to provide the margins and record levels of net profit auto dealers have enjoyed since May 2020.

The “unprecedented times” we’re experiencing look remarkably like the post-WWII auto retail marketplace when it took 10 years for new vehicle production to catch up to retail demand and have predictable depreciation for used vehicles. The largest auto manufacturers are telling North American dealers to expect reduced levels of inventory for at least two more years, maybe longer. If unmet customer demand stays at approximately 1.5 million units per year, pent up demand for new cars and trucks could be as high as eight million units by 2026. It would take four years to clear that backlog and return to a 45-day supply of vehicles at retail.

With such high demand, dealer profits should remain above historical levels for years to come, despite lower margins caused by rising interest rates. Even if gross profit margins decrease by 20-25% from the past two years’ averages, increased volume could offset decreasing margins and hold net profit levels steady. Analysts expect comparable demand for parts and service during this period, giving dealers increased profit opportunity in fixed operations as well.

What about used vehicles? As supply constraints begin to ease, prices are normalizing slightly but demand for used vehicles remains strong at retail. And commercial vehicle businesses who can’t meet user demand with new vehicles will rely on the wholesale market to supply their rental fleets. As scarcity drives pricing, fewer new vehicles today will result in fewer used vehicles tomorrow—values will be slow to decline and used vehicle prices will normalize gradually.

The auto industry is poised for transformation over the next 5-10 years—manufacturers will retool for a future with electric vehicles (EVs) and will experiment with agency models while dealers seek technology solutions to expand their value for customers. Do investors see an industry in transition as a red flag or a source of opportunity?

Current levels of M&A activity answer that question—so far, growth-minded dealers and investors remain bullish on our industry and its prospects. Although pressure from inflation, high interest rates, and staffing challenges may reduce profitability and result in dealership prices retreating from their peak, strong buyer demand will support auto retailer performance for the immediate future.

Is this dealership right for me?

When considering a particular dealership, buyers typically assess:

Management: Is there a trusted leader available to direct an acquisition and ensure it fulfills its promise? The top reason the right buyer declines an opportunity is not having the right leader for the business. There are no substitutes for leadership, and buyers may need to do a deep dive into the target’s existing management to evaluate the talent they can tap into post-close. As one public auto retailer CEO put it, “It’s easy to buy stores but much more difficult to find the people to operate them well.”

Today’s successful operator may not be equipped to compete and manage in tomorrow’s marketplace. As the customer purchase journey becomes more sophisticated, it’s critical to have data-driven people and processes along with savvy leaders to ensure the best car buying experience for customers now, and in the future.

Facilities: Electrification and the adoption of an order and wait for delivery model by consumers may make smaller dealership footprints viable for the future. So far, manufacturers seem reticent to lower land and building requirements, and brand imaging remains a major consideration when purchasing a dealership. Capital expenditures for facilities are expensive and time consuming, so astute consolidators complete detailed assessments of the condition of existing facilities and brand image compliance. In faster growing areas like Florida, Texas, the Carolinas, and Northern Virginia, future add points in their markets of interest are a vital factor—nothing changes potential like the addition of a same brand competitor.

Is it time to sell?

If you’ve decided that a sale is the best option for you and your business, you can take advantage of historically high dealership valuations.

If selling isn’t already your strategic imperative, there are other considerations that may point you in a “sell” direction:

  1. Are dealership prices likely to go higher? Economic conditions and industry factors have calmed the frenzied M&A activity that characterized the last two years, but healthy dealerships are still finding buyers at or near their asking price. The gentle slowdown in M&A is a reminder that there’s no guarantee that delaying a sale and continuing to work is a decision that will give you the financial returns you desire.
  2. Does my business have the economies of scale to be successful? Scale is critical to stay competitive in today's consolidating automotive market. As operating costs continue to rise, dealers need the cost reductions that economies of scale deliver to stay profitable.  To achieve competitive scale, you may need to acquire dealerships or sell to a consolidator, protecting your dealership's value and maintaining its commitment to your employees and your community. 
  3. Is my dealership an attractive target for a growth-oriented consolidator? There are financial investors from outside the industry who are driving M&A and looking for the right industry partners to add to their platforms. If your dealership has a solid market position, with well-run operations and a strong management team, the best answer for the stakeholders in your business—including your family and the community you serve—may be to sell. The injection of capital and growth mindset can be a powerful combination.

Change is happening across the automotive industry along with the broader economy and today's automotive industry offers attractive opportunities for both buyers and sellers. For those who understand what it takes to thrive and are willing to do that work, it’s a terrific time to be a buyer. High dealership valuations provide opportunities for sellers to make sure their plans realize their business's potential and maximize its value going forward.

Are you a buyer, a seller, or still deciding?

Give us a call at Truist Dealer Services so we can help you look at the M&A market and find the path that’s best for your business. For more information, visit us at Truist Dealer Services.