Over the past two years, we’ve written a lot about the auto industry and Tesla. This week, we are turning Placer’s sights on franchise dealerships (for example, Nissan of Miami or Oxnard Ford), many of which operate as subsidiaries of Lithia Motors, AutoNation, Group 1 Automotive (i.e., the consolidators), and the used car independents like Carmax and Carvana.
We see positive foot traffic for the franchise dealers in the first half of 2024 versus softer results in the second half of last year. Toyota has crushed in terms of visits and sales for the past year, including original equipment manufacturer (OEM) unit sales were up +17% in the U.S. Ford has also been particularly strong this year because they dropped prices on the Mustang Mach-E and had a lot more supply of in-demand models such as F-150s and Broncos. For BMW, OEM deliveries to U.S. dealers were softer in Q1 2024 (+1%) than the second half of last year. Consumer hesitancy? Higher rates? Trade down? AutoNation has been strong on repair & maintenance revenue, but weak on vehicle sales.
In looking at the used independent large dealers--CarMax and Carvana--and comparing their Q1 2024 results, CarMax was bumping along the bottom and but is now stalling. Carvana is accelerating. Placer data has a lot of efficacies for looking at Carvana unit sales; the conversion rate between unit sales to visits to their tower locations is very high at 50%. For Carmax, the conversion ratio is only 6.7% (i.e., lots of kicking the tires in their lots compared to purchases).
Looking at the two dealership networks by demographics and benchmarking to the Toyota franchise dealership group, we see Carvana winning visits, especially among the affluent. By contrast, CarMax is losing across the board.
We also see the affluence difference in cross-shopping behavior (below). Carvana is more in the mix with franchise dealerships, whereas Carmax is being cut out. The mix with franchise dealership will be more affluent. Carvana will be selling newer models, Carmax older. That dynamic has significance to their unit economics and earnings growth as we discuss below. In a higher interest rate environment, higher income shoppers will be able to afford the higher financing costs and will more easily attain the loan. As such, Carvana is producing higher unit sales; Q1 2024 saw +16% growth year-over-year, whereas CarMax saw only +1%.
For those who are less familiar with the dealership industry:
- The used car market size is nearly three times the new market, In 2023, there were 36M used units sold compared to new car sales of 12.6M units. Roughly half the 36M used cars sold are between consumers and other consumers (C2C) and the other half is from dealers to consumers (B2C). The B2C market is split roughly 50/50 between franchise dealerships and independent used dealerships.
- The unit sales mix for franchise dealerships is roughly 60% new cars and 40% used cars.
- The consolidators like Lithia look for to acquire dealerships that will be financially accretive; the accretion comes from public-to-private market arbitrage (plus systems and scale efficiency capture, and market densification). During 2023, Lithia acquired 56 locations and divested 8. Each of Lithia’s stores operates under a separate franchise agreement with the manufacturer of the new vehicle brand it sells (Ford, Nissan, etc.).
- Using AutoNation as representative of the industry and its unit economics (pre-pandemic), new car sales were 17% of gross profits, used car sales were 10%, financing & insurance 28%, and parts & service 45%. (AutoNation is the largest operator in the U.S. and it sold 506K cars last year.)
- Gross profit has averaged $1,820 per new car and $1,423 per used car for the five years prior to 2020. For 2023, these figures were $4,876 and $1,868. (Yes, that’s right, AutoNation’s gross profit from new increased by $3,000. For Lithia Motors the increase was $2,300.)
- Given the unit economics, the franchise dealer business model is based upon establishing and keeping customer relationships so that it can generate ongoing revenue and profits from the relationship in the form of financing & insurance (F&I) payments and repair & maintenance (R&M) services.
- Those dynamics also play in consumers’ minds in that they are seeking a competent and trustworthy operator with convenient locations. That renders Placer as a powerful tool for understanding a dealerships’ business, potential, and success or lack thereof. We would point to both visitors and visits, and the growth thereof, to both be key metrics in an analysis.
- Dealership used inventory comes from trade-ins, off-lease vehicles, and fleet managers (namely the rental car companies). Franchise dealers get over two-thirds of their used inventory from trade-in. Post-pandemic, franchise dealers have become less willing to dispose of used units onto the wholesale market, because they want to retain the F&I and R&M earnings streams (i.e., there has been a change in their mindset and the business capabilities and model). The change results in less trade-in units finding their way as inventory for the used independent market (CarMax and Carvana).
- Another post-pandemic challenge for independent used dealers is that current vehicle owners are less interesting in parting with their existing because of high levels of negative equity. Vehicles purchased in 2020-2022 were at elevated prices and trim levels and market prices have come down sharply since. Pre-pandemic, a two-year-old vehicle typically had positive equity, whereas 2021-2022 purchases typically have negative $4K in equity. Additionally, many consumers don’t value the latest models’ new technologies and features; as such, they prefer just holding onto their existing pre-pandemic model. All of this results in less late model used vehicles flowing to the used independent dealers.
- A third challenge is that pre-pandemic rental fleets were pruned of cars older than three years. Given all that happened with new vehicle production and supply chain, rental car companies are holding onto vehicles for longer limiting their wholesale unit sales. Moreover, many have established B2C stores for their inventory of best-preserved vehicles as they can capture a higher price than selling into the wholesale market.
- The air pocket created by the production slump in 2020-2022, plus the above three acquisition challenges, result in the independents pushing into later model vehicles (older than four years). Pre-pandemic, 80%+ of Carmax’s inventory was under four years old. Last year the figure was down to 55%.
- The later model vehicle inventory/sales mix has three negative impacts to independent used dealers’ business: (1) Given the older inventory they will mix naturally into less affluent consumers, consumers that are currently challenged to afford a vehicle given high interest rates; this results in less demand for the independent industry’s offering; (2) Older vehicles, on average, have more problems to repair pre-sale which creates more risk to the inventory acquisition and more expenses for fixing the problem vehicles, which lowers the unit economics, and (3) All of this narrows the market and concentrates the competition for used vehicles, which in turn, results in them having to their acquisition prices without the offset of a higher retail price, resulting in lower unit economics.
