2015 Auto Dealer Economic Outlook

Low gas prices and easy credit translate into strong volume and sales of larger ticket vehicles for dealers going into 2015. U.S. sales of cars and light trucks totaled 16.5 million in 2014, over a million more sales than in 2013. The industry sales in 2014 surpassed the 16 million mark for the first time since 2007. Gross profit margins have begun to compress at dealerships as competition intensifies, but average fixed operation profit grew at a nice clip in 2014. After forecasts underestimated vehicle sales in 2014, many industry experts are bullish about 2015.

SAAR

U.S. light vehicle SAAR ended 2014 at 16.8 million units, a 9 percent year-over-year increase. The industry has apparently carried momentum into 2015, selling 3.6 million vehicles during the first two months of 2015, a 5.9 percent increase over the prior year. SAAR for the end of February was 16.2 million units. The chart below shows historical SAAR since 2004.

Many industry experts expect the industry to break 17 million units in 2015, nearing the industry all time unit sales peak of 17.4 million set in 2000. In its January 2005 Industry Research Update for the automotive industry, GE Capital forecasts 17 million SAAR in the first quarter of 2015 and 17.4 million units for the year. TrueCar is forecasting 17 million units sold in 2015. AutoPacific predicts an annual unit sales increase of 0.5 million in 2015, ending the year just shy of 17 million. LMC Automotive believes unit sales will reach 17 million by the end of the year, and goes on to forecast 2016 sales to reach 17.1 million. LMC long-term outlook for the industry is in a range that tops out at 18.3 units and has a worst-case scenario of 16.6 million.

It no secret that growth within the industry has been stellar since the recession ended in 2009, as a result of pent-up demand and an improving employment picture. Many analysts and industry leaders expected the industry to cool in 2014. Senior Director of Consulting & Analytics for J.D. Power expected the industry to increase annual sales only 0.5 million, rather than the 1 million that resulted. Jim Lentz, Toyota North American Region CEO, said he was expecting Americans to buy 16 million new cars, also 0.5 million short. Barclays automotive analyst, Brian Johnson, at last year Society of Automotive Analysts conference, gave a range of 16.2 million to 16.4 units sold, just shy of actual reported sales.

The vice president of OEM operations at JD Power, Thomas King, provided his view for the industry in a January 2015 Automotive News article by Lindsay Chappell. JD Power expects the industry to deliver the second highest new-vehicle volume in history in 2015. King stated that customer satisfaction is at its best level ever, transaction prices are up $700 per vehicle from a year ago, and dealers can expect to turn an additional 400,000 sales this year. He cautioned that volume growth was getting tight for existing models. JD Power market data show that 70 percent of mainstream models were able to generate year-over-year volume increases between 2011 and2013. But last year this number dropped to 59 percent.

NADA expects the volume split in 2015 to be 56 percent light trucks and SUVs, and 44 percent cars, with most of the growth coming from pickups and SUVs (and compact utility vehicles). The growth of light trucks and SUVs have outpaced that of cars since the end of 2010, and low gas prices will certainly increase the rate of growth for larger vehicles.

Vehicle Pricing

New cars are being sold for their highest price ever, according to TrueCar and Kelley Blue Book. The estimated average transaction price for light vehicles in February 2015 was $33,299, a 3.6 percent year-over-year increase. The average transaction price during all of 2014 was $32,804, a 2.2 percent increase over 2013. According to Kelley Blue Book, the increased price tags were a result of highly contented vehicles (vehicles with numerous added options). Daimler saw the largest increase in transaction prices, up 4.9 percent from 2013. Mitsubishi reported the largest decrease in prices during 2014, down 4.1 percent.

NADA reported in February 2015 that average incentive spending per vehicle for the month was just below $2,600, marking 26 consecutive months of increased incentive spending on a prior-year basis. In conjunction with Daimler sales growth, Mercedes-Benz incentive spending increased 60 percent. Fiat Chrysler, also showing strong year-over-year sales gains, had big incentive increases in four out of five brands. Ford and General Motors bucked the trend by cutting back on incentives, yet managed to improve sales. Among the Japanese brands, Nissan increased incentive spending 17 percent, while Honda and Toyota cut back in February 2015 compared to prior year.

2014 was also a record year for used vehicle pricing, according to Edmunds.com. The average transaction price for a used vehicle was $16,800, a 5.6 percent increase from 2013. The chart below was highlighted in Edmunds.com 2014 Used Vehicle Report.

Franchised certified pre-owned (CPO) unit sales increased 10.9 percent in 2014, and with an average price premium of $1,341 over other used vehicles, were a big contributor to the overall average used price increase. Edmunds.com reported that 2014 recorded the highest volume of CPO vehicle sales and percent of market share on record. New vehicle leasing continues to grow and the lease returns have helped supply used car inventory, particularly CPO vehicles.

Edmunds.com provides three primary reasons for the increase in used prices, newer used inventory, lower gas prices, and cheap and easy credit. About 19 percent of vehicles two years and younger, considered to be near new were purchased in 2014, relative to only 13 percent in 2013. The fall in gas prices has led to more purchases in trucks and SUVs, which generally have higher price tags than other vehicles. Translating into higher purchase power for consumers, auto loans have gotten cheaper and terms have gotten longer, shown graphically in the chart below (Source: Edmunds.com).

Profits

According to NADA, the November 2014 year-to-date total gross profit for dealerships increased 5.2 percent over the previous year; however, gross profit margin contracted, falling to 13.3 percent from 13.5 percent. The contraction in overall dealer gross profit margin was reflected in the shrinking margins for new and used vehicles. Average new vehicle gross profit per unit fell 1 percent from $1,204 to $1,193, with gross margins declining from 3.81 percent to 3.68 percent. Average used vehicle gross profit per unit fell 0.4 percent to $2,361 from $2,370, with margins moving from 13.13 to 12.55 percent.

Public dealers are performing better than the industry averages. Haig Partners produces The Blue Sky Report each quarter, and included in its reports is an analysis of the public dealer per unit gross profits through the third quarter of 2014. Haig reports that the average new unit gross profit was $2,220, up 1.3 percent year-over-year. Looking back to 2007, average gross profit per new vehicle was greatest in 2011 at $2,478. Average used gross profit per vehicle was $1,781, representing a 0.8 percent year-over-year increase. The higher average gross profit for new vehicles relative to used is likely symptomatic of public retailers' penchant to push high-line vehicles, generally producing higher gross margins.

Haig reported that public dealers have grown their fixed operations 7.1 percent for the year-to-date ending September 2014, better than the 5.5 percent growth demonstrated by private dealers during the same period. Also covered in Haig report is that public dealers are showing strong growth in their F&I departments, with gross F&I profit per vehicle at an all-time high of $1,292, up 5.5 percent year-over-year.

The average pretax profit among all dealers is up. NADA reported the average November 2014 year-to-date pretax profit for dealers to be $996,825, a 4.9 percent increase over the same period in 2013. Average pretax profit margin was 2.4 percent, unchanged from the same period in 2013.

Automotive Loans

Vehicle loans reached an all-time high in 2014, according to Experian Automotive. Loans for new and used cars reached $886 billion at the end of 2014, up from $800 billion in 2013 and $721 billion in 2012. Banks and credit unions provided 59 percent of the total financing; captive auto, 26 percent; and other finance companies, 15 percent.

The collective risk profile of borrowers is mostly unchanged since 2012, with super prime borrowers (credit scores > 781) making up 20 percent of the total amount borrowed, and subprime borrowers (credit scores < 501) also accounting for approximately 20% of the total. A consistent distribution of borrowers by risk profile is generally a positive sign for the industry.

According to Experian Automotive, 84 percent of new vehicle purchase and 55 percent of used were financed in 2014. These percentages have been steadily climbing, with the amount of new and used financing totaling about 75 percent and 46 percent, respectively, in 2009.

The average interest rate for financing a new vehicle in the fourth quarter of 2014 was 4.56 percent, up 19 basis points year-over-year. The average interest rate for financing a used vehicle was 8.65 percent, down 6 basis points year-over-year.

Mergers & Acquisitions

The industry was very active in 2014, highlighted by a couple of major acquisitions made by big names. Berkshire Hathaway announcement in October to purchase Phoenix -based Van Tuyl Group represents the largest acquisition ever in the industry. The acquisition of Van Tuyl Group, the fifth-largest auto retailer in the U.S., selling over 219,000 vehicles a year, could have a price tag of around $2 billion, based on the current values of public companies. The actual value of the transaction has not been disclosed. The transaction was finalized in 2015. Another large deal of note was the finalization of Lithia Motors' purchase of DCH Auto Group, with revenue of nearly $2.3 billion from 27 dealership locations. The total transaction was valued at $366.5 million.

Kerrigan Advisors in its March 2015 Blue Sky Report, stated that 206 dealerships were acquired in 2014, up from 115 deals in the previous year. The report also showed that there were 44 multi-dealership transactions for the year, relative to 30 the year before. The report states that while demand of domestic franchises is very strong, buyers had a greater appetite for import franchises (both luxury and non-luxury) in 2014.

In its quarterly report, Haig Partners proposes that an increasing willingness by lenders to finance blue sky is a major factor in the increase in the number of deals and the value of transactions in the industry. In a survey of captive finance companies, Haig Partners found that lenders are very bullish on automotive dealerships, with many saying they would finance 50 to 100 percent of the total price of blue sky, real estate, and other acquired assets. It went on to note that it not unusual to see cross collateralization on multi-dealership companies, but that the requirement for a dealer personal guarantee is becoming less common as competition for loans in the industry heats up.

Analysts believe the industry will continue to consolidate as long as credit remains available and the industry performs well. The dealership industry in the U.S. is still highly fragmented, with the top 125 dealer groups accounting for only 16 percent of the 17,875 dealerships in the U.S.

Economic Drivers

As of February 2015 it has been 68 months since the U.S. economy reached an economic trough a termed used by the National Bureau of Economic Research to describe the last time the economy receded, rather than grew. The average number of months the economy has gone trough-to-trough since 1854 is 56.2 months, possibly indicating that the U.S. economy is about a year overdue for another recession.

The stimulus efforts put in place by the Federal Reserve have undoubtedly worked, as the U.S. economy has outpaced most of the rest of the developed world in growth since the end of the recession in the summer of 2009. The chart below, created by Goldman Sachs, shows the U.S. gross domestic product (GDP) growth relative to other parts of the world.

Unemployment has fallen to 5.5 percent as of February 2015, the top of the range considered by many Fed policy makers to be full employment. Traditionally when the labor market tightens, wages increase, and the risk of inflation becomes a concern. To combat the threat of inflation, the Fed will raise interest rates.

Many question if inflation is imminent despite the drop in unemployment. Wage growth has been tepid since 2009, with hourly earnings growing only 1.98 percent year-over-year in February 2015. Prior to 2009, it was common to see annual growth rates above 3 percent. The chart below shows annual increases in private, non-farm earnings since 2007.

The Consumer Price Index (CPI), which measures the general change in consumer prices, declined 0.1 percent over the 12-month period as of January 2015. Energy led the decline, with an 18.7 percent year-over-year drop in the price of gasoline. Without gasoline in the measure, the CPI would have risen 0.1 percent, still a very low number, relative to the Fed target annual inflation rate of 2 percent.

The Federal Reserve met in mid-March to discuss interest rate policy. The Fed has kept short-term rates near zero since 2008, and many believe the question is not if the Fed will raise rates in 2015, but when it will raise rates. The effect of a rate hike on dealerships in the short-term should be marginal, as any move will certainly be minimal. An increase in rates, and subsequently the market reaction, will likely have more of a psychological effect on consumers than a real effect on spending power.

The Wealth Effect

The Wealth Effect is described as the change in spending that accompanies a change in perceived personal wealth. Consumers typically spend more when they feel richer, usually as a result of the increased value of their home or a booming stock market, regardless of change in actual household earnings. When individuals see the value of their 401-k increase, or the selling price of their neighbor house gets them excited, they are more likely to make a large purchase, such as a vehicle.

While disparity of wealth may be widening in the U.S., on the whole, Americans are wealthy and are feeling good, which bodes well for retailers. U.S. household net worth reached a record $83 trillion at the end of 2014, a 1.8 percent increase from the previous year, and a 51 percent increase from the economic trough of 2009. In 2007 net worth peaked at $67.9 trillion, but then fell 19 percent to $54.9 trillion in the first quarter of 2009 before it began to rise. As evidence that the consumer feels good, the University of Michigan Consumer Sentiment Index in January reached the highest point since 2004, indicating that consumers haven't felt this good in a long time.

Conclusion

The general outlook among analysts and industry leaders is more positive than in the beginning of 2014, perhaps because most of them had expectations that fell short of reported results. Much of the consumer behavior is dictated by how they feel, and if they feel wealthy and that their job is secure, they're probably more apt to buy a car. A rate hike by the Fed in 2015 could have more of an adverse psychological effect on consumer actions, rather than a real effect on their wallets or their ability to finance an automobile. Gas prices also drive consumer behavior, and if prices stay at current levels, buyers are more willing to purchase larger ticket items - trucks and SUVs. It been a good start to 2015, and if most of the experts are right, it should carry on throughout the year.

Article compiled by Travis Flnniken, CFA, CVA, Valuation and Litigation Specialist.

Sources:

• Bureau of Economic Analysis
• The Blue Sky Report, A Kerrigan Quarterly, 2014 Full Year Report, March 2015
• St. Louis Federal Reserve, FRED Economic Data
• NADA Data, Annual Financial Profile of America Franchised New-Car Dealerships 2014
• NADA Dealership Profile, November 2014, www.nada.org
• Guidelines - NADA Used Car Guide Industry Update, www.nada.org, February 2015
• 17 Auto Predictions for 2015, Fearless and Feckless, Forbes, Taylor, Alex. December 30, 2014
• Detroit Automakers all Post December Sales Gains, The Detroit News, Marines, Michael, January 5, 2015
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• National Association of Realtors economic data, www.realtor.org
• U.S. Census, Housing Starts, www.census.gov
• Broadest Unemployment Measure Less Rosy, Wall Street Journal, Morath, Eric, March 15, 2015
• The DCH deal: How Lithia will Absorb its New Asset, Automotive News, LaReau, Jamie, June 23, 2014
• Lithia Completes Purchase of DCH Auto Group; LaReau, Jamie, October 1, 2014
• Kelley Blue Book Recaps 2014, Forecasts 2015 Automotive 2014, kbb.com, January 9, 2015
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• February 2015 U.S. LV Sales Thread: SAAR falls to 10-Month Low, WardsAuto, March 3, 2015
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• 2014 Used Vehicle Market Report, www.edmunds.com
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• State of the Automotive Finance Market, Third Quarter 2014, Experian, Zabritski, Melinda
• AutoPacific Forecasts Three More Years of Growth for U.S. Light Vehicles Sales, www.autopacific.com, Grieb, Deborah, February 19, 2015
• Automotive Loans at All-Time High, The Detroit Bureau, Strong, Michael, February 20, 2015
• J.D. Power and LMC Automotive Report: New-Vehicle Retail Sales in February Expected to Cross the Million Mark, J.D. Power, McGraw Hill Financial Press Release,
• Industry Research Update, Automotive, GE Capital, January 2015