The Changing Model of Auto Dealerships Presents Long Term Investment Opportunity

We are headed for a vicious shakeout. He who survives will be far stronger in the end. A recent study by consulting firm Grant Thornton showed that for average dealer sales to match last year’s average, about 2,000 dealers need to close. With sales imploding, the firm has raised the number to 3,800. About 600 of the 2,000 new car dealerships in the US have closed to this point. In September alone, that number was 61.

Paul Melville, a partner at Grant Thornton, says they “badly need retail consolidation” to have healthy dealers. “Significant consolidation is necessary, especially among Ford (F), General Motors (GM) and Chrysler retailers,” he says, “because U.S. sales already have declined more than 1 million units this year.”

The domestic automakers want their dealer numbers to be more like those of Toyota (TM) or Honda (HMC). Toyota has fewer than 2,000 U.S. dealers while Ford has almost 4,000. That means your typical Toyota dealer sold 1,628 vehicles in 2007 while Ford stores averaged 236. GM dealers averaged 202. The average for all new car dealers was 322.

Domestic manufacturers want their store counts and revenue counts to look like Toyota and Honda, because many less dealerships means selling more per dealership.

“The business model of huge, irrational inventories and huge, irrational marketing budgets with razor-thin margins, à la the Bill Heard model, is obsolete,” says Mike Jackson, CEO of AutoNation (AN), the USA’s largest chain of dealerships. “It’s dead. It will not survive this downturn.” Bill Heard, which sold over 7% of Chevy's nationwide recently closed. 

Jackson says the future of car sales — coming soon — will be fewer dealerships having less need to wheel and deal. They can hold the line on price, pumping up the profit per car, and focus on customer service.

“At the dealer level, a shakeout needed to happen,” he says. “It will be painful. It will be ugly. But it is also long overdue.”

This would explain why Berkshire's (BRK.A) Warren Buffett and Sears' (SHLD) Eddie Lampert are buying shares of both AutoNation and CarMax (KMX). It is clear both will be left standing after the shakeout is over and both will have substantially increased market share through the attrition of rival dealers.

In my interview with AutoNation's Jackson recently, he said he was content to sit back and watch the industry shakeout happen as it "was necessary".

When will things begin to turn? Clearly late 2009, perhaps into 2010 for the industry as a whole. But, as Jackson also said, when it happens there will be "significant postponed demand for autos". What that means is that fewer dealers will be selling cars for higher profit to a surge of car buyers.

That means Jackson and his shareholders stand to profit handsomely.

Disclosure: Long AN

Comments

[Paul Killinger:]

These guys are dreaming. While a shakeout of undercapitalized dealers was long overdue, the big boys' model isn't any better. Publicly traded auto dealers will continue to underperform forever.

This is one economic niche that will always be dominated by small to mid sized entrepreneurs. As we've witnessed recently in a variety of industries where there isn't any meaningful product differentiation, bigger isn't always better.

2008 Oct 23 08:47 AM

[Paul Killinger:]

If auto manufacturers thought they could improve their dealer model, they would have long ago. A few big dealers make it easy for them, which they like because they're inherently lazy. (Who can doubt this having witnessed their past performance?)

As for dealer chains being able to increase markups and profits, this is utter nonsense. Buyers can now easily access invoices, incentives and used car values on-line, and this trend will only continue to grow as time goes on.

Savvy consumers even compare prices at DIFFERENT Wal-Marts, so they're now going to begin to overpay for vehicles? I doubt it. But I'll say this, whatever these guys are smoking it must be some terrific stuff!

2008 Oct 23 09:14 AM

[Paul Killinger:]

As for the so-called "future" of car sales, it's already here. Buyers can research their vehicles from their laptops, and have them delivered to their homes for $100 over invoice (less incentives and holdback) if they want to. They don't even have to set foot in a dealership anymore, much less overpay for the privilege.

2008 Oct 23 09:36 AM

[billddrummer:]

To paulk,

I agree with you. There's no real reason to have dealers on every corner hawking the newest and greatest. There are already a myriad of channels for buyers to look for cars that don't involve dealers, and that trend will continue as people become more and more comfortable with online (and other means) shopping.

2008 Oct 23 01:07 PM

[casey00001:]

You are forgetting that a lot of people now buy their car online. You can build it at the manufacturers website and find the MSRP. Then go onto Edmunds.com to figure out about what you should pay. In GM's case you can even find out which dealer has your car on the lot. No more dealing with a sleazy salesman. Send them an email with the price you are looking for and if they are not agreeable, on to the next. No more burning gas and cycles looking for a car/truck.

2008 Oct 23 02:44 PM

[billddrummer:]

Don't forget the buying clubs run by Sam's Club, Costco and the like. They'll cut you a deal as well.

And while we're on the subject, if anyone wasn't aware that there's lots of room in new car prices, how is it that manufacturers are offering thousands of dollars in incentives to get you to buy now? MSRP means nothing, and probably hasn't for years.

The only people paying full boat now are ones who are 1)stuck or 2)stupid.

2008 Oct 23 05:06 PM

[fcharlie:]

And what if you want to test drive a car?? How do you do that online?

2008 Oct 25 05:15 PM

[billddrummer:]

To F Charlie,

Visit your friendly neighborhood dealer and walk away without a sales contract.

Although a former salesman at a dealership here in Reno forged a customer's signature on a sales contract and had the lot boy deliver the vehicle to her!

She had it repoed, and the car eventually got auctioned locally for thousands less than list.

But that's what I'd do. I was stuck, so I ended up overpaying for my new car. Read my earlier comment. I knew I was overpaying, but had no choice.

2008 Oct 27 01:46 PM