Report reveals there may be tough times ahead for car dealers

According to a report released today by Ernst & Young, plummeting car sales, heavy discounting of new vehicles and lower levels of servicing work have combined to catastrophic effect on the automotive retail market in the UK, which has seen franchised dealership insolvencies double year on year.

The report reveals a total of 24 dealer insolvencies up to the end of August of this year, compared to 12 for the same period in 2008.

“UK Car Dealerships – Lessons from the last recession” – provides a perspective on the current and future trends in the UK automotive retail market and highlights the different effects on the sector between this economic slowdown and that of the 1990s.

Dealerships in the doldrums

Eric Wallbank, UK head of Ernst & Young’s automotive team, said the severity of the recession on the wider automotive sector is well documented but its effect on the dealer industry has been equally severe.

“Production shut downs, GM and Chrysler filing for Chapter 11 Bankruptcy and a string of component suppliers going to the wall have dominated the headlines in recent months. But UK franchised dealerships, the last link in the global automotive chain, are suffering an equally severe effect.

“A cocktail of falling sales and diminishing profit margins has led to unprecedented levels of dealer closures. But the true extent of distress facing dealer groups is being masked by the closure of many loss making sites which would have not been reflected in the overall insolvency numbers.”

New car sales light on profits

The report also reveals the heightened fragility of dealers during this recession when compared to the 90s, as a result of the significantly lower profit margins being made in the run up to this recession. The UK’s top 25 dealers reported 7.1% EBITDA in the period 89 – 90, compared to 3.1% in 06 – 07.

A significant contributing factor to this decline in profit margins is that while new car sales typically represent 50% of turnover, they only make up 25% of gross profit. Conversely, aftersales only make up around 15% of dealer revenues but is the largest generator of profits with some dealers targeting and delivering over 50% of gross profit from this source.

Aftersales hit the slow lane

However, as Wallbank explains, the overall slump in new car sales over the last 18 months will lead to weaker demand for servicing and parts from franchised dealers in the medium to long term, further adding to their profit woes.

“The strength of new car sales until mid 2008 should sustain dealer servicing volumes in the near term, but the impact of a drastic fall in sales from then on will be hard felt across franchised dealers over the next three year’s or so.

“Add to this better build quality, longer service intervals and a consumer trend towards smaller vehicles and the future outlook for servicing volumes will be downwards for years to come. And if a dealer is representing a marque which has lost market share then they could be facing even steeper declines in revenues.”

Light at the end of the tunnel?

While it is difficult to predict whether the Scrappage Scheme will help carry the industry through the worst of the economic crisis, the report says that the most promising indicator of recovery in new car registrations is likely to be a return to Gross Domestic Product (GDP) growth.

Wallbank says, “Looking back to the early 1990s recession it is clear that there is a strong correlation between new car sales and GDP growth.

“But even if sales do pick up in line with GDP, it is difficult to see new car registrations returning to the record levels of 2.6 million within the next decade. The sales boom in the years leading up to the ‘credit crunch’ was driven primarily by the availability of cheap credit, and financial institutions will remain far more cautious over lending for some time to come,” he adds.

Supply and demand buoys used cars

The used car market has experienced a turnaround in fortunes in recent months. This has been boosted by a fall in production of new cars, resulting in fewer cheap deals on new cars; and lower new car sales, creating a decline in the level of customer trade-ins and hence reduced supply of used vehicles. Both of these factors have helped to reverse the decline in residual values experienced during 2008.

Wallbank comments, “The recovery in used car residual values has resulted in a one-off profit on used car stocks for dealers and this has been a significant contributor to the stabilisation of dealer profitability in the first half of 2009.

“Despite the Scrappage Scheme, the residual values of used cars should continue to hold up because of the lack of availability of good used car stocks.”

Tough times ahead

Although the economic crisis appears to have stabilised, there are still real uncertainties for the dealership sector which will continue long after the UK emerges from the recession. Vehicle manufacturer instability, the lack of available finance for consumers to fund new and used vehicles and falling demand for aftermarket services are all likely to adversely impact profitability for dealers.

Wallbank says conditions will get worse for dealers before they get better, “We expect the number of dealer failures and site closures to accelerate into 2010 as the full effects of the current drop in car sales are felt.

“The franchised dealers best placed to weather the storm will be those able to retain a significant proportion of customers’ aftermarket spend and those representing growth brands. This is particularly true of dealers offering a strong line of smaller vehicles which are proving to be increasingly more attractive to changing consumer tastes.”