Pub. 57 2016-2017 Issue 2

37 WINTER 2016 and the Carbone Auto Group, in the last 12 months and is engaged to sell two additional top 100 groups. Kerrigan Advisors extensive experience representing the largest dealership groups in the country provides the firm with a unique perspective on the trends shaping the industry and today’s franchise values. This experience informs The Blue Sky Report™ and our market commentary. With this backdrop, Kerrigan Advisors has identified the following three trends which are expected to affect the in- dustry for the remainder of the year and into the New Year. • Auto retail’s hedged business model sustains dealership profitability • Economies of scale and scope drive consolidation • Foreign interest in US auto retail rises Auto Retail’s Hedged Business Model Sustains Dealership Profitability The auto retail business model is highly resilient. Even in the face of the Great Recession, when auto sales declined by 50%, the average private dealership remained profitable, according to NADA. Similarly, the public dealership groups remained cash flow positive from operations throughout the recession. Few industries in the world can sustain a positive bottom line after a 50% decline in their primary revenue source; however, US auto retail can because of its highly attractive, hedged business model. US dealerships rely on three revenue sources: new cars, used cars and fixed operations. When considering the interplay between these three revenue sources, it becomes clear why dealerships usually remain profitable regardless of the busi- ness cycle. Generally speaking when new vehicles sales decline, used vehicle sales and fixed operations increase. Though new vehicle sales are the largest portion of an aver- age dealership’s revenue (see Chart XI), new vehicles rep- resent just 27% of an average dealership’s gross profit. This is due to the fact that the average dealership’s gross profit on a new vehicle is just 6% when including F&I income. By contrast, fixed operations, which represents just 11.6% of an average dealership’s revenue, has a gross margin 7.5 times higher than the new car department, and represents nearly half of a dealership’s gross profit. This means that for every $10 dollars lost in the new car department, a dealership needs to increase fixed operations sales by just $1.33 for its gross profit to remain flat. Chart XI Average Dealership Departmental Sales and Gross Profits and Expected 2017 Growth Rates Source: NADA Average Dealership Financial Profile and Kerrigan Advi- sors Estimates Chart XII Average Dealership Gross Profit Margin by Department Source: NADA Average Dealership Financial Profile and Kerrigan Advi- sors Estimates As the growth in new vehicle sales declines, dealerships are already seeing their fixed operations growth pick up considerably (see Chart XIII). Fixed Operations 11.6% Fixed Operations 46.3% Used Vehicle 30.9% Used Vehicle 25.9% New Vehicle 57.5% New Vehicle 27.5% Departmental Sales as % of Total Dealership Sales Departmental Gross Profit as % of Total Dealership Gross Profit Expected Growth Rate New Vehicle: +2% Used Vehicle: +4% Fixed Operations: +8% 6% 12% 45% New Vehicle Used Vehicle Fixed Operations 7.5x