Car dealerships in for a rough ride during 2008

Ernst & Young’s Annual Car Dealership Report

Friday 4 April, 2008: The car dealership industry is set for one of its worst periods in many years as a result of economic uncertainty, waning consumer confidence and ever decreasing disposable income, according to Ernst & Young’s 2008 Car Dealership Report.

The report goes on to say that the dealerships most at risk are the small to medium sized operations – those with sales less than £100 million – as their reliance on used car sales will be impacted by a consumer slow down and by manufacturers putting incentives behind new cars, coupled with their inability to leverage economies of scale, which will squeeze profit margins to breaking point.

Rising sales but falling profits in 2007

David Duggins, Ernst & Young partner and co-author of the report, says that against a back drop of increasing sales during 2007, 49% of small to medium dealerships have reported annual losses and with a challenging climate for car sales predicted, he feels there maybe many casualties at the smaller end of the sector in 2008.

“The overall increase in new car sales in 2007 gives rise to the impression that the industry overall had a good year,” he says. “But if you consider that the small to medium dealers had a tough time breaking even in 2007, it would suggest that many small to medium sized dealers could be heading into financial distress.”

Bigger means better for sales and profits

Examining the latest results publicly available for UK dealers reveals that the majority reported an increase in sales last year, but large and mega dealerships (revenue above £100 million) fared best, with 75% showing growth.

Among medium sized dealers (revenue £25 – £100 million) 72% showed sales growth but only 64% of small dealers (revenue below £25 million) achieved an increase in sales.

Commenting on the significance of these sales figures, Eric Wallbank, Director of Ernst & Young’s automotive team and co-author of the report, says, “The figures demonstrate that there are clear benefits of scale in the drive to increase sales.”

Continuing, he says, “To a large extent, the dealers who saw sales rise were those that were selling the products of particular vehicle manufacturers (VM). Most notably, the growth VMs were Mini, Audi and Land Rover from the premium sector and Vauxhall and Honda from the volume manufacturers.”

In terms of dealer profitability, the mega and large dealerships had a good year, with 83% and 78% respectively reporting profits. But small and medium dealerships are doing less well, with only about half of them delivering profits.

Wallbank says there also seems to be advantages of scale between the large and medium sized dealer groups with regards to profit delivery, with the average profitability of large dealer groups greater than that for medium-sized groups.

M&A activity in neutral gear

The report suggests that the pressure on margins and level of downward share price movements witnessed in the sector would have driven a wave of consolidation in any other industry, especially among smaller participants. Also, the fact that the number of dealers in the UK are on a constant path of long term decline – from 6,463 in 1997 to 5490 in 2006 – would also point to consolidation in the sector.

Wallbank says the relative lack of M&A activity is at first glance surprising. “When we look at the lessons learnt from some recent acquisitions in the sector, however, it becomes clear that post integration has proven very challenging with cultural, systems and process issues all coming to the fore. This has led to the strategy of many acquisitive groups pursuing single site or franchise acquisitions, and being very careful with any large scale acquisitions.

“We are also seeing a process of consolidation by osmosis, as smaller dealers, tempted by rising development land values of inner city sites, are selling up and leaving the sector. This leaves open slots in the manufacturer’s network which are often filled by large dealer groups,” he says.

Private equity interest, says Wallbank, which has been a driving force behind M&A in other sectors, has never been a significant factor among car dealerships. “The growth potential and margins that PE houses look for are simply not present in the sector and the level of control over outlets held by OEMs are unattractive, so we see little prospect of PE involvement going forward.”

The road ahead

This year is going to be tough for any sector relying on buoyant consumer spending, and as consumers’ disposable income is eroded by increasing living costs - in the form of rising mortgage repayments, energy bills and food - car sales will be impacted as a result.

The SMMT has forecast new car sales this year to be 2.45% down on car sales in 2007 and Duggins says this prediction is a notable slow down in the market and the final outcome could be an even sharper downturn if consumer confidence continues to slide.

Concluding, he says, “Faced with a contracting market, far sighted dealerships are tightening their working capital management, focusing on cash flow, margins and profitability. In what promises to be one of the toughest years of the last decade, it is the smaller dealers, especially those carrying losses, which are likely to feel the pain.”

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