Kerrigan Advisors’ Founder Erin Kerrigan predicts unprecedented buy/sell activity through 2022. - IMAGE: Getty Images

Kerrigan Advisors’ Founder Erin Kerrigan predicts unprecedented buy/sell activity through 2022.

IMAGE: Getty Images

The dealership buy/sell market is as red hot as the market for new and used automobiles, according to the First Quarter 2021 Blue Sky Report from Kerrigan Advisors.

Kerrigan’s analysis reveals an “unprecedented” 300 transactions over the past 12 months and reports this trend continued through the first quarter of 2021 where unique market conditions resulted in 66 completed transactions, an increase of 20%, over the first quarter of 2020.

Erin Kerrigan, founder and managing director of Kerrigan Advisors, attributes the skyrocketing buy/sell market to historic profit levels at dealerships of all sizes, locations, and franchises. As profits soar so do franchise valuations, she says. Kerrigan Advisors puts the average dealership’s blue-sky value at $8.5 million, up 10% over 2020 levels and 33% over 2019 valuations. 

“Our industry has benefited from tremendous consumer demand,” Kerrigan says. “We have limited inventory and a business model that is flexing its muscle to show what it can do when dealerships aren’t oversupplied by vehicles. The entire industry sees there is much more profit to be had in auto retail, the largest retail industry in the world.”

Booming Market Attracts New Buyers

“The pandemic, while very challenging, was a once-in-a-lifetime event that made 2020 a record year for the automotive buy/sell market, whichhas been extended and amplified by auto retails’ tremendous profitability in Q1, fueling a historic level of acquisition activity this year,” Kerrigan says. 

Kerrigan Advisors’ research finds dealership profits spiked 82% compared to the six-year pre-pandemic average, resulting in a 4.1% net-to-sales margin. Consumer buying spurred by pandemic stimulus payments and low-interest rates kept purchases at record levels. 

The booming market has attracted both strategic and new entrants to auto retailing, creating a “huge demand for dealerships,” she says, noting existing family dealerships and high net worth individuals seek to buy more dealerships. 

“The industry attracts buyers for several reasons,” she adds. “Auto retail has shown through thick and thin that it can remain profitable, and even make more money in challenging times, as it has proven in the last 12 months.” 

The hedged business model of dealerships helps recession proof these businesses, according to Kerrigan. A dealership is four businesses in one: new car sales, pre-owned vehicle sales, F&I and parts & service. When business in one sector falls off, it typically increases in another sector.

Kerrigan explains, “If consumers are not buying cars, they are often keeping their cars and servicing them. There’s a 10-to-1 ratio between service margins and new vehicle sales margins. This means service margins are 10 times higher than new vehicle sales. Dealers can lose $10 of new vehicle revenue and need just $1 of service revenue for gross profit to remain flat.”

Dealers’ ability to adjust variable expenses is also a plus. A dealership’s primary fixed expense is its rent and real estate. When business falls, dealers can trim marketing budgets and reduce their workforce to retain profitability.

Digital retailing also will drive down fixed costs, adds Kerrigan. “The biggest variable expense for dealers is personnel. Digital retailing reduces the number of personnel needed to sell a car, meaning more profits drop to the bottom line,” she says. “Digital retailing will be a profitable shift for most dealers.” 

She adds, “The bottom-line margin is at 4% right now. Margins are usually at about 2% to 3%. If a huge percentage of your expense is personnel, and you can reduce personnel expenses through digital retailing, you will see more and more dealerships make upwards of 10% net-to-sales in the future.”

The pricing power manufacturers give dealers is also an advantage. Kerrigan explains the current pricing structure allows dealers to increase prices—and grow profit margins—when supply becomes limited. On the flip side, when sales decline, dealers can discriminately price vehicles to increase gross profit. 

A fixed pricing model could slash profit margins. If Volvo and other manufacturers successfully enforce a fixed pricing model, Kerrigan predicts it may curtail dealer success as dealers could no longer adjust pricing to market forces.

“The OEMs’ attempts at creating a single pricing structure for new vehicles is a challenge to car dealers,” she says. “It is something that state associations and dealers’ associations should lobby against because the current pricing model drives the success of our industry to some degree.” 

2021 and Beyond

Record earnings led to record market capitalizations and contributed to higher blue-sky multiples than seen at the close of 2020.  In fact, Kerrigan Advisors calculates the publics spend on acquisitions increased 220% in Q1 2021 versus Q1 2020. 

Lithia Motors Inc., one of America’s largest automotive retailers, led acquisition activity. The automotive retailer closed on 10 dealerships during Q1 2021 as it works to attain its stated goal of adding $50 billion in revenue in five years. 

Multi-dealer transactions represented one-third of the completed transactions in Q1 2021. Kerrigan Advisors finds capital market support contributed to the 53.3% increase in multi-dealership transactions. Sales of import non-luxury franchises also increased in Q1, rising seven percentage points to 37%. Toyota led the way at 8.3% of all import non-luxury franchises.

Kerrigan Advisors’ research predicts the industry will see similar buy/sell activity throughout 2021. The industry will experience increased consumer demand, high dealership profits and an accelerated buy/sell market for some time, Kerrigan’s founder agrees.

“While I do not have a good crystal ball, I believe the high level of buy/sell activity will last at least through next year.  I expect auto retail will continue to experience extremely high levels of profitability through 2022 which will drive acquisition spending,” she says. “As with vehicle inventories, a limited supply of sellers coming to market, relative to buyer demand, will continue to result in very high blue-sky prices. This coupled with low interest rates should be a recipe for high valuations through 2022.”

However, she foresees disruption on the horizon; the first being increased interest rates. 

“Not only are car sales sensitive to credit and the credit markets, but the buy/sell market is too,” she says. “These transactions are highly financed and very expensive. Dealers are turning to debt markets to finance the transactions. Higher interest rates would be a huge risk factor not only to the industry but to the buy/sell market.”

Originally posted on Auto Dealer Today