As we've eluded two over the past year, a consolidation and narrowing wave looks forthcoming at both the automotive original equipment manufacturers (OEMs) and dealerships. Let us explain why.
Tesla’s Q2 2024 quarterly results fell below expectations, as its cutting prices on its vehicles to drive demand is crimping profits and cash flow. The “cash-on-the-hood” increases reflect the category's competitive intensity between so many brands as well as the category’s share loss to hybrid vehicles. For perspective, Tesla units sold decreased -5% year-over-year, production fell -14% (slowed to trim excess inventory), prices fell -7%, cost per unit is flat, and gross profits decreased -28%. Is Tesla in trouble? No. Is the electric vehicle (EV) category’s rapid growth and the transition from internal combustion engine vehicles (ICE)? Very much so.
What does it all mean? Deflation has hit the category hard and that will creep into the broader industry as well. The OEMs will need to simplify their businesses, product lines, and take costs out. The high unit profits that the franchise dealers made on new vehicle sales will march lower and they gravitate to initiatives to retain the long tail of those new units (in the form of repair & maintenance and financing & insurance). Success with those initiatives will be dependent on the convenience and ease-of-service of a dealer, contemporized consume engagement & processes, store & service standards, etc.
For perspective, GM, Ford, and Stellantis (Chrysler, et.al.) also reported quarterly results this week. On the slower pace of EV adoption, GM CEO Mary Barra said, “Over the next 3 years, third-party forecasters now see the EV market growing steadily, but more slowly than it did over the last few years. As a result, we are adjusting our spending plans to make sure we're capital efficient and moving in lockstep with customers...As we go forward, we're going to bring additional capacity online in a measured cadence. This will enable us to better optimize our battery chemistry and form factors to meet our customers' needs on cost and range.” Lastly, the OEMs have a similar problem in China as the luxury industry; it has a large, growing, and profitable market that could move the needle, but that market has deep overcapacity and transitioned to battery electric vehicles (BEV), leaving the legacy OEMs trying to milk the value they can get from it, before they eventually exit. That makes their success in the U.S. all the more critical; it’s going to continue to be a dynamic time in the industry here. Success will depend on true and bold vision and excellence in execution.
Ford’s CEO Jim Farley on the transition said, “And we clearly see China and Tesla as the cost benchmark. We also see excess capacity that will lead to more pricing pressures, which is in our business plan, more consolidation and many, many more partnerships. We see less vertical integration in some areas to relieve capital, and we see a lot of tough choices on footprint. Early majority customers are really different than the early adopters, particularly in retail, and we see a lot more openness to hybrids and extended range electric vehicles we call EREVs. We also see a divergence on electrification adoption between commercial and retail. Commercial customers focus on total cost of ownership, they use the vehicles much more intensely, and they do not overbuy batteries that retail customers do...We believe smaller, more affordable vehicles are the way to go for EV in volume. Why? Because the math is completely different than ICE. In ICE, the business we've been in for 120 years, the bigger the vehicle, the higher the margin. But it's exactly the opposite for EVs. The larger the vehicle, the bigger the battery, the more pressure on margin because customers will not pay a premium for those larger batteries...With no engine or drivetrain, a smaller vehicle can have a much roomier package, actually the interior package of a class above, with a small silhouette. That's a big advantage for customers versus ICE. And we're focusing on very differentiated vehicles priced under $40,000 or even $30,000. And we're going to focus on 2 segments: work and adventure. And why does this matter? Well, the use case for smaller vehicles, affordable vehicles, means shorter trips, more urban locations. It fits the duty cycle of an EV.”
As we touched on in our story in early June about the auto dealership market, the industry is changing with franchise dealers becoming more wired about driving up their used and long-tail business (maintenance & repair and financing & insurance). With the change in the business model, the business KPIs and their weightings will evolve, loyalty metrics and “share-of-garage” will become especially important. Below, we show the Placer loyalty visitation metrics. As shown, Ford has a higher loyalty rate than GM and Chrysler and in-line with Mercedes. GM and Chrysler rank evenly with BMW and ahead of Toyota. Year-to-date, the U.S. OEMs figures are little changed, by contrast, Toyota is up by 46 basis points. In terms of industrywide unit sales growth, Toyota is lead horse, pace-wise at the moment. We think for those with interests in the automotive industry, that watching the loyalty figures on an absolute and relative basis is an important edge creator.
Another point on the prior topic of loyalty, Group 1’s Q2 2024 investor presentation shows retention is in the 70% range for vehicles up to 8 years of age, which is when most vehicles are out of warranty and into a second owner’s hands/garage (making the retention on the original sale a much more difficult proposition). Being able to produce this level of retention, along with Group 1’s market share gains in both new and used on a comparable basis, requires a modernized sales and consumer service proposition (Group 1’s AcceleRide digital customer buying platform is a good example) and crack execution. That favors scaled players that have contemporized and digitized the consumer touchpoints and operations and why the consolidators like Group 1, Lithia, and others will continue to make acquisitions to enter new markets (i.e., the cost to win and the “table stakes” are rapidly increasing).
Lastly, share-of-garage can be looked at on a market-by-market basis. For example, in Houston, many households will have two, or more, vehicles in their garage. How share-of-garage relates to the Group’s and other consolidators, is that these companies want to maximize the number of vehicles that they sold to a household, regardless of OEM. This allows them deeper insights into these households auto-related purchases and services; those insights allow the consolidator ways to optimize the spend and life-time-value that the extract from the household. And so, it's what drives the returns, and those better returns is what is driving consolidation in the franchise dealership industry. How many of those are a Group 1's dealerships versus the competitors. The table below shows that Group 1’s Sterling McCall Toyota, their number-one dealership by visits in the Houston market, has gained share-of-garage in Houston as visitors to a Sherling McCall sister-dealership is up 13%, outperforming visitors to competing dealerships is up only 10%. To understand Group 1’s total portfolio, the exercise would need to be repeated for each franchise dealership.
