The sky is falling, according to the headlines. They say poor economic conditions, dropping stock values, rising interest rates, and unchecked inflation will lead to disastrous outcomes for every industry, including automotive.

But dealers responding to the 2022 Kerrigan Dealer Survey remain bullish about the future value of their businesses and acquisition plans, their perspective on specific franchise valuations, and future industry earnings.

The survey results discovered that most dealers report a positive outlook on valuation over the next 12 months, 60% projecting 2022’s record valuations will sustain through the year.

However, overall dealership expectations for valuation increases and decreases tell a different story. Just 20% of dealers reported they expect valuations to increase in the next 12 months, down from 61% compared to 2021 and the lowest level reported since 2019. And 20% of dealers expect to see a decline in valuation in the next 12 months, a 233% increase from 2021, when just 6% projected a decline. That’s the highest rate of expected decline since 2019.

According to Kerrigan Advisors founder and Managing Director Erin Kerrigan, the results reflect a trend of flattening valuations in the years to come. Still, she predicts dealership valuations will stay the same in 2023 after years of annual valuation doubling.

“The survey saw a significant decline in the percentage of dealers expecting dramatic increases in valuation and profitability,” she says. “There are changes in the mix. In 2021, everyone was performing at record levels. We saw the same in 2022 as the constrained supply of vehicles, combined with the tremendous amount of capital infused into the economy, resulted in every single franchise seeing record earnings this year.”

CHANGES ARE COMING

Dealers’ views on future profitability are consistent with the flattening of valuation expectations, according to the survey results.

Just 34% of surveyed dealers project an increase in profits over the next 12 months, while 24% predict earnings will decline and 41% expect earnings to be flat. The results reflect the negative effects of rising interest rates, lower consumer sentiment and high inflation, Kerrigan says.

Interest rates hit historic lows but are creeping back up. The Federal Reserve increased the prime interest rate in October and November, impacting the rates of vehicle loans. According to Investopedia, the average interest rate on a car loan in October was 10.6%, almost double the rate earlier in the year.

Inventory levels also are normalizing, which will impact dealer profits, Kerrigan says. The CDK Global Inc.’s Vehicle Ease of Purchase Scorecard supports the trend. The research found consumer-preferred in-stock vehicle availability jumped 20% in October, compared to 37% in September. In October, 44% of customers found the vehicles they were looking for at the dealership, with fewer customers waiting for in-transit or factory-order deliveries.

“As interest rates rise and inventory levels increase, you are going to see more winners and losers,” Kerrigan says. “That’s why in 2021, you saw 61% of dealers expecting an increase in their value over the next 12 months, compared to just 20% expecting that now. That’s really emblematic of some franchises expecting to see a decline in profits in 2023.”

FRANCHISE FOCUS

Almost every franchise saw a reduction in the percentage of dealers projecting an increase in value. In fact, most franchises saw an increase in the percentage of dealers expecting a decline in value compared to 2021.

Kia, Hyundai and Toyota had the most dealers expecting valuation gains over the next 12 months: over 40%. It’s the second year Kia and Hyundai made the list and the first time those franchises surpassed Toyota to top the results.

The survey also found that dealers with Toyota, Lexus, Porsche and BMW franchises say they are least likely to decline in value. In fact, over 90% of surveyed dealers expect those franchises to either increase in value or remain the same over the next 12 months.

Meanwhile, the list of franchises with the highest expected valuation declines includes Infiniti, Lincoln, Acura, Buick GMC, Cadillac, Ford and Volvo. Over 30% of surveyed dealers expected those franchises to decline in value over the next 12 months.

“It’s important to watch the supply of vehicles,” Kerrigan says. “I’m seeing that as supply rises, particularly with some domestics, their profit comes down, which will correlate with their valuations coming down. Toyota is still supply-constrained, and the demand for these franchises continues to outstrip supply, so those valuations will remain high or increase.”

Another highlight of the franchise focus is Honda, which lost market share last year and had the most negative survey results involving change from 2021. “They were just behind Ford,” Kerrigan says. “That’s shocking to me; Honda has always been such a strong franchise.”

Nissan seems to have turned a corner, she says. “They had the best results compared to 2021. They really improved their position in terms of the number of dealers with negative valuation outlooks. They also sustained improvement among dealers who felt their valuations would increase. That puts them in pretty positive territory compared to other franchises.”

BUY-SELL ACTIVITY

Despite dealers’ negative views on future profitability, Kerrigan Advisors reported few dealers expect to sell their dealerships over the next 12 months. In fact, nearly half of dealers surveyed expect to acquire dealerships in the next year. That mirrors industry consolidation trends and increased levels of buy-sell activity reported in The Blue Sky Report.

“I expect elevated buy-sell activity to continue through the first half of 2023,” says Kerrigan. “That’s partly because some of these transactions take a while to get approved. A lot of deals that get signed in the fourth quarter close in the first or second quarter.”

She expects buy-sell activity to remain high as the year progresses because so many dealers signaled an intent to scale their businesses through acquisitions. “Scale continues to be a key factor in many dealers’ view of success. The idea of having just one or two franchises no longer seems like a viable plan for a future fraught with disruption in retailing and increased focus on electric vehicles.”

According to the report, the industry’s focus on expansion means that significant scale is required to succeed in the dynamic and ever-evolving auto retail marketplace. As a result, a disproportionate number of dealers are planning for growth rather than exits.

For that reason, Kerrigan Advisors expects a seller’s market to persist throughout the year. Kerrigan predicts current valuations will hold over the next 12 months because of the dealership supply-demand imbalance. But she also predicts that could change as a poor economy pushes some dealers to exit before a full-blown recession.

“We continue to see more buyers than sellers,” she says. “Going into 2023, you could see more dealers saying, ‘Look, the economy is changing. I think I will sell.’ That could increase buy-sell activity because we still have tremendous liquidity in the industry. There is a lot of capital available to make acquisitions, which dealers also are eager to do to ensure they have the scale to succeed.”

INDUSTRY TRANSITIONS

The automotive industry is in transition as disruptors like direct-to-consumer sale models, digitization, and a shift toward EVs threaten to change the way things are done.

Kerrigan says dealership valuations are based on future profits. “So, when you have OEMs experimenting with how dealerships will make money in the future, it creates a challenge in how to value future profitability. But our survey revealed the buyer community looks at these announcements as a bunch of noise because they are not pricing in an unexpected change in profitability.”

Most dealers believe the changes won’t affect future profitability. Some dealers even think the changes will improve profits, with Toyota dealerships having the most positive expectations. Ford, Chevrolet, Buick, GMC, Cadillac and Lincoln, as well as Volvo, are the domestic franchises with the most negative expectations.

“59% of Ford dealers surveyed believe the changes Ford is making will have negative impacts on future profits,” Kerrigan says. “Nevertheless, the highest-volume Ford dealers are excited about the future of Ford. It is the small dealers who are the most negative.”

Kerrigan says that makes sense because Ford requires significant investments to participate in its electrified future. The company offers two levels of participation, with dealers at the low end paying $500,000 and dealers at the high end paying $1.2 million.

The adage that you can’t fight the Feds is alive and well, according to Kerrigan. The biggest risk factor for dealership valuations moving forward is interest rates.

“That will be the biggest driver because the consumers’ ability to purchase cars will be affected by higher interest rates,” she says. “We’ve already seen consumers’ savings rates return to pre-pandemic levels, so there will be fewer funds available for down payments. And that will be the biggest risk factor to our industry in 2023.”

However, she stresses that the auto industry has shown resiliency against every risk that comes its way. “Auto retailers have proven their ability to sustain profitability, even in tough times, by focusing on other aspects of their business. I am confident they will do that again.”

Ronnie Wendt is an editor for F&I and Showroom magazine.