Moody’s Investors Service has released a new report addressing concerns on profitability of auto dealers.
Concerns about profitability following drop in new vehicle sales is overblown
As auto dealers brace for a fall in new vehicle sales for 2019, Moody’s believe concerns about potential hits to profitability are overblown. Over the past four years, new vehicle sales have hit record or near- record highs exceeding 17 million units, a level the sector will potentially miss this year. Through June, new vehicle sales were off 2.4%, or roughly 200,000 units, though the June SAAR (Seasonally Adjusted Annual Rate) was holding above 17 million at 17.3 million. While the top-line impact of reduced new vehicle sales will likely be very real, the diversity of the dealers’ business models, particularly their collective focus on used vehicles, will largely protect profitability and therefore credit profiles.
Over the past several years, the profitability engine in the vehicle sales portion of the dealer operating model has shifted toward used models and away from new, with new now actually the least profitable of the sector’s four segments: new sales, used sales, parts & service and finance & insurance. New vehicle dealers have been putting much more emphasis on improving their used businesses the past few years, which means that anything short of a precipitous, recession-like drop in new vehicle sales can be absorbed with little credit impact. While we expect softening new vehicle sales to cause overall revenue to decline 3-5% in 2019, strength in used vehicles, parts & service and finance & insurance will preserve gross and operating margins, similar to 2018, when revenues were flattish to down slightly and gross profit was flattish to up slightly.
It’s the profits, not the sales, that really matter
Sales of new vehicles, which generated 54% of the rated public sector’s revenue in 2018, provide foot and website traffic, which is invaluable from a marketing perspective. However, used vehicles can provide the same, if not better, opportunity, because this segment drives a significant portion of the customer-pay business for parts & service. Bottom line, new vehicle dealerships make their real money servicing and financing vehicles, not necessarily by selling them, though unit sales drive traffic to parts & service and finance & insurance.
Tariffs present an opportunity for used vehicle sales
Given the diversity of the brands and models for the new vehicle portfolios throughout the rated universe, the dealers are actually very well-protected against potential tariffs. In the event tariffs impact the price of New Vehicle A, the dealer will likely be able to switch a potential buyer to New Vehicle B, thereby preserving the sale. If the prospective buyer is wedded to New Vehicle A, the customer may find a certified or used version palatable, which the dealer would sell at a higher margin than the new vehicle. In the event tariffs are imposed, it stands to reason that used prices for tariff-impacted vehicles would increase due to the potential substitution effect.
Online has become a critical tool for marketing
Actual online sales of new vehicles are de minimus, but the internet still remains a critical tool for auto retailers. Websites are the “entry point” for most consumers, because almost all new car buying begins with online research. Up-to-date new and used car inventories and prices, online chat capability and online scheduling of service appointments are now “table stakes” for auto retailers and this requires investment. Target direct marketing to past and prospective customers is another necessary capability. While meaningful new online vehicle sales are not likely anytime soon, we note capability is increasing, but for used sales, the story is very different.