With all of the April numbers in, it was time to check in with Ryan Kerrigan for the Kerrigan Report. Bridget Fitzpatrick of CBT News recently interviewed Ryan to find out how Aprils numbers shaped out to be and what that means moving forward in the next quarter.
Bridget: Now how did the Kerrigan Index fair for April?
Ryan Kerrigan: It was a very quiet month in the stock market. The Kerrigan Index was down 0.7%, which slightly underperformed the broader market, which was up 0.3% in April. Amongst the component stocks, Sony was up a notable 5.1% for the month, and Lithia was down 4.9%.
Bridget: So it was a stable month for the Index?
Ryan Kerrigan: Yes, a stable month. However, we do have some interesting news in that we anticipate adding AutoCanada to the Kerrigan Auto Retail Index later this year. AutoCanada’s the largest retailer in Canada and the only publicly traded auto retailer in Canada, and they’ve just come south of the border for the first time, entering the US. If they continue with their US expansion, we’ll be adding them to the Index later this year.
Bridget: That sounds like big news. Tell us more about the expansion.
Ryan Kerrigan: Yes. This is one of the international transactions that we discussed in the past. Closing on April 9th, we’re pleased to represent our client, the Grossinger Auto Group, and their sale to AutoCanada. The Group represented 15 franchises in the Chicago Land area, and marks AutoCanada’s entry into the US market. And that means we now have a seventh potential consolidator in the US with a publicly traded currency.
Bridget: Why Chicago and why the Grossinger Group?
Ryan Kerrigan: Each buyer has a different profile. In this case AutoCanada sought a large platform with multiple volume franchises, with a preference for a major northern metro. In our prior conversation with the AutoCanada team, we thought this would be a good fit for them.
Bridget: Is this a sign of more to come? More of these cross border transactions?
Ryan Kerrigan: Yes, we believe it is. We are aware of other Canadian groups that are pursuing acquisitions in the United States, and we continue to have active conversations with groups from Europe, the Middle East and Asia, they’re evaluating acquisitions as well. So yes, we do anticipate more cross border transactions.
Bridget: And overall buy sell activity remains strong?
Ryan Kerrigan: Yes, it certainly does. We anticipate that 2018 will mark the fifth year in a row of 200 transactions or more in the industry. And coming out of the recent NADA conference in Las Vegas, we sense that the pace of change is accelerating.
Bridget: Now, what is driving that? Is this motivating some dealers to sell?
Ryan Kerrigan: Well, it’s a confluence of old drivers and new. Generational turnover within the dealer body has been going on for quite some time, and that will continue. However, we’re now seeing all the attention on the changes in our business model playing an increasingly bigger role. The chatter about major change, driven by technology, as gotten dealer’s attention. This is motivating many dealers to assess whether or not they’re able to make the changes and take the risks necessary to be successful in the next phase. In some cases families are doubling down and committing to growth and innovation to stay relevant. In other cases dealers are coming to the opposite conclusion. The disruption, the investment and the risk are simply not something that they want to take on, and that is accelerating their thinking as it relates to selling.
Bridget: So with all this change, who benefits?
Ryan Kerrigan: It’s a great question. As we assess this, and we do look at this, we see these changes playing largely to the benefit of the larger groups. They have bigger budgets and staff to evaluate all these new technologies and new ways to serve customers.
Bridget: Are there advantages to dealers who decide to grow?
Ryan Kerrigan: We’re seeing larger groups able to negotiate down their SG&A expenses, particularly as it relates to technology subscriptions, in a way that’s giving them a significant cost advantage on the cost side. SG&A as a percentage of gross profit is 17% lower for the public dealers as compared to the average private dealer. Now that’s a very strong recipe for industry consolidation, and that’s exactly what we’re seeing.
Bridget: How is the proliferation of social media impacting all of this? Do you see any relevance in the transaction market?
Ryan Kerrigan: Yes, as a matter of fact we do. We see buyers much more focused on the perception of dealerships in the local marketplace when they consider acquisitions. Buyers know that reputation is sticky and difficult to change quickly. As a result, we’ve actually added CSI and SSI as the sixth major factor that can push blue sky multiples up or down when assessing a given opportunity.
Bridget: All right. Any other hot topics in the marketplace that you want to touch on?
Ryan Kerrigan: One of the other topics I’d mention is a renewed conversation about facilities. A Sonic executive recently said out loud something that many had been saying privately. And he said, “We’re just not going to get caught up in the game of building these new facilities like we’ve been asked to build in the past. We’re just not going to make those investments, unless the investment warrants it, and we’re not going to be bullied into that situation either.” These facilities are just too big and too expensive. And as a result, we’re seeing rents continue to rise, up 37% since 2010, and 11% in the last three years.
Bridget: How much rent is that per new vehicle sold?
Ryan Kerrigan: This amounts to $825 per new vehicle sold in 2017.
Bridget: Wow, that’s a big number.
Ryan Kerrigan: Yes, it is. In our view these ever larger facilities are not consistent with the direction of retail and how consumers want to buy. Now as it relates to OEMs wanting to put forth a highly professional store front to represent these important purchases, I get it. I recently spoke to a large group of Honda dealers on the East coast, and understand that some of the facilities that Honda was complaining about in that meeting do not represent their brand well. But in some cases, OEMs are pushing for bigger and more expensive facilities that largely mirror the store across town, and that’s just not the general direction of retail. As we see it, retail is shifting either towards unique experiences to engage the consumer and reinforce the brand, or highly efficient, convenient places at which to transact. From our perspective, building larger, lookalike dealerships is last gen retail, not next gen retail.
Bridget: All right. Why is this an issue now?
Ryan Kerrigan: It’s coming to a head because new car volumes are trending down slightly, gross margins continue to shrink and interest rates are rising. As interest rates rise, the cost of these new facilities will be felt even more. Lithia CFO said recently on an earnings call, “A one percent move in interest rates is a $50 million pre tax expense for Lithia.” Now let me be clear, we don’t see dealers declaring war on the OEMs, but just pushing for more balance as we enter a period of very real uncertainty for many dealers who are trying very hard to figure out what lies ahead.