Dealership Valuations - Planning During a Market Downturn

While much has changed in the dealership landscape since the last recession, (i.e. additional industry consolidation, increased technology use, more potential disruptors, etc.), we suggest the past can teach us several lessons as we look forward to the future.

Strong, Diversified Operators Position Themselves Well for Recovery

Market downturns are difficult, and this is no different for those in the dealership industry. The last recession saw a significant decrease in the number of franchised auto dealers in the U.S. According to the National Automobile Dealers Association (NADA), there were 21,495 new-car dealerships in 2006; however, this decreased to 17,700 new-car dealerships by 2011. The below table presents the salient financial metrics for the average dealership during that time period.

Average Dealership Profile Table

Source: NADA Industry Analysis Division

Despite the decrease in sales and profitability in 2008-2009, by 2011 the key financial metrics of sales and pre-tax earnings not only recovered from recessionary lows but reached record levels. The years following the recession proved to be very profitable for most auto dealers, with NADA reporting average dealership sales of $61,552,452 and pre-tax earnings of $1,423,848 (or 2.31 percent of sales) in 2019 – a significant further increase from the table shown above. By focusing on strong operations across the diverse dealership business model, dealers that survived the last recession were able to capitalize during the recovery and growth period that followed.

Market Multiples May Dip During a Significant Downturn

Based on our experience, market multiples reflect the risk associated with a given dealership as perceived by the market, and the multiples are inversely related to that perceived risk. As the perceived risk decreases with the “safety” of a given brand, the market multiples increase compared to other more risky brands. The same is true with profitability, real estate location, condition and suitability, economic outlook, dealer market representation, etc. As the risk of any of those factors increases, the market multiple generally decreases, and vice versa. We saw this relationship evidenced very clearly in the 2008 recession when we observed downward pressure on multiples due partially to profitability and economic risk. While many dealers choose to hold on to their dealerships during an economic downturn rather than accept a lower price, we did witness a decrease in both earnings and multiples during the recession based on the limited buy/sell activity and pricing levels of the public dealership companies, as shown below.

6 Publicly Traded New-Car Dealership Companies graphic

Source: S&P Capital IQ, DHG Dealerships Analysis. Excludes data with negative market multiples.

The 2008 section of the above chart stands out in particular as both the average pre-tax earnings margin and the average market multiple were considerably lower than immediately prior to or following the recession. Looking back, this was a great time to be a buyer, but the extreme uncertainty (i.e. risk) at the time caused the implied valuations to decrease significantly.

Tax Planning Opportunity for Ownership Transfers

The potential decrease in transaction and transaction prices that generally accompany an economic downturn can provide an excellent opportunity for owners to implement various estate and transfer planning strategies. The increase in perceived risk, combined with lower levels of marketability (fewer dealership transactions, longer cycle time on the transactions, etc.) can allow owners to transfer dealership interests to future generations, trusts or other planning vehicles to help protect the longevity and viability of their dealerships during an economic downturn and in the ensuing recovery. For those who have remaining gift tax exemption, this may be a particularly beneficial time to implement gift and succession strategies.

With the Tax Cut and Jobs Act (TCJA) including a doubling of the estate and gift tax exemption through 2025, as well as the uncertainly involved with the upcoming 2020 election and current market conditions, now could be a great time to discuss planning opportunities with your advisors. For more information or to speak with an advisor, reach out to us at info@dhg.com or contact the author(s) listed below.

About Dealerships

DHG Dealerships is one of the largest professional service teams providing assurance, tax and advisory services to dealers across the country. We collaborate with key industry stakeholders to enhance the insights we bring to our clients and provide them access to valuable resources.