There are more than 16,000 auto dealerships in the U.S. and most are small businesses. If you think about it, auto retail really is the last
bastion of the mom and pop industry. But large dealership groups are gobbling up smaller shops. The pace reached a frenzy during the coronavirus pandemic
when new car prices soared. Six of these companies are publicly traded and they are on
a roll. Sky high profits and incredible share price performance. There are 16,000 stores in the U.S. Right. Some of these bigger guys have 300, 400 stores. So that gives you an indication of just how big and how
fragmented it is. And that's, I mean, frankly, that's one of the reasons why
the story is so appealing, because it is so fragmented, it's so big, and there's so much opportunity
for consolidation and growth. But these companies face some challenges ahead. Consumers are growing ever more accustomed to buying things
online. New carmakers such as Tesla and Rivian are selling cars
directly to consumers using digital tools, bypassing dealers entirely. And record high vehicle prices have irritated customers and
earned rebukes from automakers. There is even talk that the dealer franchise laws may be
unsustainable in their current forms. So what is the state of auto dealerships in the U.S. and why are investors flocking to them? These are the six publicly traded auto dealership
companies. AutoNation used to be the biggest dealership group in the
country, but lately its rival Lithia Motors has surpassed it. Lithia outsold AutoNation in the first
quarter of 2022 and then again in the second. Sales at both companies have been rising
dramatically for a decade. Even before then, during the depths of the financial
crisis, dealerships were doing better than many other businesses. Lithia and AutoNation's closest rival in terms
of revenue and size is Penske, another massive dealership group. The dealership business model, it's always been incredible. In '08-'09, dealers saw their average margin industry-wide
drop to about 1%. Historically, they've been at about 2.5%. They were back up to 2.2% the next year. In 2011, AutoNation sold $13.8 billion worth of cars. That number was $20.4 billion in 2020. And in just a year, sales skyrocketed by about 25%. Net income soared even higher. Between 2020 and 2021, net income grew from $382 million to $1.4 billion. Lithia's rise is even more striking. In 2011, the company reported about $2.7 billion in sales. Between 2020 and 2021, sales nearly doubled. Net income went from $56 million in 2011 to $470 million in
2020 and up to nearly $1.1 billion just one year later. There were 383 acquisitions that year. The six publics made 29% of them. They spent $9.5 billion. In 2011, Lithia reported it owned 85 dealerships. By 2021 that climbed to 278. AutoNation's pace has been more modest in the last decade,
but they also started with more dealerships. The pace of consolidation accelerated so much that if we
continued at that pace, in 25 years or so, we would have sold every single car
dealership in the country. In certain markets, high growth markets like Colorado, 17%
of the dealerships in that state traded hands in '21. The boom in auto sales was fueled by a few factors. First, inventory was tight due to production shutdowns at
the beginning of the pandemic, but the ongoing challenge remains chips and other supply shortages. At the same time, you had a drop in public transportation
usage. Ride sharing included. And then you had this exodus from kind of urban areas to
the suburbs and more rural areas where a lot of people needed transportation. So it created a lot of first time car buyers. Basic economic principles. Supply is low and demand high. Prices go up. In normal times, dealers carry large inventories and have
to discount much of it in order to move it. They aren't doing that now. Lighter inventories, so it's costing unit sales, but there's
no discounting. And for an industry that historically has been based around
assuming there's some discounting on each car, they're all earning higher profitability per unit. And so from a free cash flow standpoint and earnings
standpoint, it's been fantastic. Over 80% of vehicles were sold at over MSRP in January of
'22. As the pandemic has worn on, consumers started driving more. That meant more servicing at the dealers. Parts and service is probably 40% roughly of a dealer's
gross profit. So that profit stream is coming back again at a time where
expenses are lower. Dealers buy cars from the manufacturer and fund those
purchases with financing. So lower inventory means lower borrowing costs. They also had to get a lot more efficient during the
pandemic. A lot of what would have been done by hand in the office is
now online, partially because of the need to cut staff. We saw a 27% increase in employee productivity industrywide
as compared to pre-pandemic times, and we ultimately also saw
more than two times increase in profitability from pre-pandemic periods. These companies have seized on the opportunity. In July 2022, AutoNation announced its plan to buy back $1
billion of its own stock. They bought back more than 25% of their total outstanding
shares in a single year, which is something I've never seen in almost 20 years as an
equity research analyst. So they're actually taking that cash and redeploying it into
the business in ways that they think create long-term value. So if the market's not going to give you credit for it
today, in my opinion, like deploying it into high returning M&A, into buying back your shares repeatedly are a way to
longer term drive shareholder value. While the auto dealership business appears to be thriving,
it does come with challenges, especially today. The franchise laws enacted in the earlier days of the auto
industry were designed to protect dealers from competition from or unfair treatment at the hands of the
automakers whose cars they sold. The laws more or less require new cars to be sold through
dealers. This was to prevent an automaker from, say, opening a store
across the street from one of its own dealers. Companies such as Tesla have no dealers and want
to sell cars directly to consumers. Earl Stewart runs a Toyota dealership in North
Palm Beach, Florida. He used to own one other dealership that he sold. Manufacturers would much rather go direct today. They're looking at Tesla and Elon Musk and his success. I mean, good work. Tesla has the number one selling luxury
car in America and they have no dealers. So the only reason the dealers exist today is because of
the state franchise laws that were lobbied in by car dealers and their
associations. But analysts are not expecting the end of franchise laws in
the U.S. anytime soon. Even absent such strict laws, manufacturers might still
want to rely on a franchise dealer network. About half of dealers profits come from parts and
service and they are the only ones who are permitted to do warranty service work. Some of the skepticism around EV startups hinges on whether
they can scale a direct sales model, especially when it comes to providing service. There was a Takata airbag recall several years ago which
involved the replacement of airbags for 67 million cars in the U.S. If Tesla were involved with that, I don't know how they
would have addressed that with a mobile fleet. Dealers do suffer some reputational challenges though. One especially controversial point lately has been the price
of vehicles. Even manufacturers have come out criticizing dealer
markups. Dealers in charge of two, three, four, five, ten thousand
dollars over an SRP. I think we're reaching a breaking point in the consumer. They're educated and they're just not going to take it
anymore. And this is going to trickle down to the legislators and
the people that need to get elected, the voters. So will this affect big dealership groups? If perception of the dealer suffers, it could have
ramifications for anyone selling cars. Automakers can't dictate prices for cars, but they do have
some levers they can pull. They have to approve the sale of every dealership in the
U.S. The other lever automakers can use is allocations. How many cars a dealer gets? It is based first and foremost on how much you sell, but it
also can be based on customer service scores and how much you invest in your business. That's the bread and butter, particularly now, when every
dealer is scrambling for that incremental unit. No one wants to lose allocation. Analysts say more acquisitions and new businesses will drive
shareholder value. The plans for some of the most acquisitive publics, Lithia
and Asbury, have said that they plan to acquire $17 billion of additional revenue. They are also then building out a network, a brick and
mortar network, and simultaneously investing in their technology
solutions such that each of those dealership points can have a larger
reach. As acquisitive as these companies have become, there is
still a lot more room to run. Even AutoNation and Lithia, two of the largest auto dealers
in the U.S., still only have about 2% market share each of the new vehicle market. So it's extremely fragmented and there's a lot of room to
grow via acquisition for these companies. Having this national network is an asset in itself. These companies are also moving online, which allows them
to expand their footprint even further. The largest groups are committing a lot of capital, trying
to figure out the best solutions. The ones that work most seamlessly for the consumer. They are certainly, both the dealer and the OEM, highly
aware of Tesla's success in selling direct to consumer in a relatively minimal
footprint of bricks and mortar. Lithia has made a move into lending, which rivals may try to
emulate. These kinds of moves show they are aware of the threats. Perhaps the biggest threats they face are from each other. Competition can mushroom out of nowhere. And a lot of people appear to be interested in buying out
rivals. It may take a while, but the era of the family-owned car
dealership may slowly be coming to an end.
