by Laurie Giesen
It’s one thing for the auto industry to turn in a better 2010 than 2009, but just how much more profitable will 2010 be? While the start of 2010 remains challenging for many dealerships, the argument can be made for measurably higher profitability this year.
“New car sales are going to grow by a double-digit number,” says Paul Taylor, economist for the National Automobile Dealer Association. “That will help the profitability of their businesses.”
In addition to putting more money in the dealers’ coffers directly from the sales themselves, the increase in new-car sales should add to the dealers’ inventory of good used cars from trade-ins. And more used cars are what many dealers desperately need to boost their used-car business. Other factors pointing to a stronger year is the continued exit of dealerships, which should help the margins of those surviving. And a slightly stronger economy overall should help push the sale of luxury cars, which tend to have higher profit margins than smaller cars.
John Tomlinson, analyst of offline retail sales for New York-based Majestic Research, expects that the number of new cars sold will reach 12 to 13 million this year, up from about 10.4 million new cars sold in 2009. “We expect sales to improve this year, but our projections are tempered by the fact that they will still be nowhere near the 2007 sales figure of 16.7 million,” says Tomlinson.
The NADA is basing its sale increase projections on the fact that many consumers can’t hold off replacing cars much longer. Additionally, improvements in the economy and a decline in corporate layoffs should help consumer confidence enough to boost car says, Taylor says. Also, the fact that housing prices do not appear to be falling continuously should help car sales.
“Most states have seen the bottom to falling real estate values. That is important to car sales, because for the typical family, the household equity is the biggest source of assets,” Taylor says.
Not only should stabilized real estate prices help consumers who want to use home equity loans to fund car purchases, but more importantly, it will help boost consumer credit scores and also give consumers more confidence to buy a new car.
“ Consumers will feel it is okay to borrow money now. When they kept seeing their housing value decline, there was a hesitancy to borrow money for a new car.” — Paul Taylor, Economist, National Automobile Dealers Association
“Consumers will feel it is okay to borrow money now. When they kept seeing their housing value decline, there was a hesitancy to borrow money for a new car,” Taylor says.
Yet, slightly stronger sales in recent months and better cost-containment programs implemented by dealers have resulted in higher average dealer net profits before taxes – and that trend should continue. Net profit for dealerships at the end of the third quarter for 2009, for example, was 1.7% compared to 1.3% for the same quarter in 2008.
“We expect to see that number even a bit higher this year,” says Taylor.Other recent financial metrics for dealerships also show improvement. For example, dealers’ debt-to-equity fell to 1.37% at the end of the third quarter of 2009 compared to 1.5% for the same period in 2008, and return on equity was 21% for 2009 compared to 17.8% for 2008, according to the NADA. Taylor also expects these trends to continue in 2010. The increase in new-car sales should not only help dealers’ new-car business, but also help used-car sales, because for the past year the usedcar business has been held back by a declining surplus of good used cars.
“About 60% of new car sales involve a trade-in,” says Taylor. “An increase in new sales will bring about a badly needed increase in used cars. The drop in sales for the past two years took about 8 million cars out of the used-car market and good used cars have been in short supply.”
Marguerite Watanabe, president of Atlanta-based Connections Insights, a consulting firm, agrees.
“Every dealer wants more good used cars to sell. In the past, they’ve had to go through repo auctions to get inventory. Trade-ins are a lower cost way to your used-car inventory,” she says.
In recent years, many dealers relied on income from service departments to make up for the shortfall in car sales as consumers who delayed new-car purchases spent more on repairing existing cars. While the sales portion of total income will increase in 2010, dealers should continue to see a strong revenue stream from repairs, Watanabe says. And although more auto dealers are expected to go out of business this year, it is expected to be fewer than last year. NADA figures show that 1,772 dealers went out of business last year, and Taylor says he expects about 1,000 more will close down this year. But, he adds, that is good news for the remaining dealers, which will benefit from the diminished competition.
Watanabe warns, however, that the benefit won’t be universal. “It all depends on where they are located,” she says. “Will they pick up customers from competitors that go out of business or will a lot of those customers simply move to the next town?” She uses the example of a mid-size city. If a Buick dealership there goes out of business, the nearby Ford dealership may not benefit if customers simply purchase cars from a nearby town. However, if the nearest dealership is 30 or 40 miles away, customers might rethink their brand loyalty. Also helping dealer profits is the fact that dealers are doing a better job of inventory management and controlling their fixed costs, says Majestic Research’s Tomlinson.
“Dealers have been doing a better job of keeping the right size of inventory on hand,” he says. “If there is an incremental increase in sales, that should roll right to the bottom line.”