17 million or bust? Red flags for retailers

on May1

The industry has crossed the line into risky territory on automaker incentives, leasing levels and new-vehicle inventory, said AutoNation Inc. CEO Mike Jackson.

His comments came as publicly traded dealership groups released mixed earnings results for the first quarter. While other executives didn’t explicitly endorse Jackson’s view, most indicated that incentives, leasing and new-vehicle stocks have reached or exceeded healthy limits. The retailers are managing, but not easily.

“It’s clear the industry intends to sell over 17 million vehicles this year, if I look at the inventory and the production plans,” Jackson said.

But Jeff Dyke, Sonic Automotive Inc.’s executive vice president of operations, said that without hefty factory incentives, today’s natural sales rate is closer to 15 million.

Jackson believes automakers are using incentives and leasing to reach the 17 million new-vehicle sales goal. Leases accounted for 31 percent of new-vehicle sales in 2016, according to Edmunds.

“To me, 30 percent leasing has always been a red line, where you’ve had a massive distortion if you take it above that,” Jackson said. He called incentives that top 10 percent of sticker prices another red line, and inventories above a 70-day supply yet another. “So we have three red lines that the industry in total is over on new vehicles,” he said.

Last month, automaker incentives increased 13 percent to an average of $3,511, Jackson said. Average per-vehicle incentives have reached 10.5 percent of the sticker price, he added. And AutoNation’s new-vehicle supply was 71 days in the first quarter, vs. the industry’s 73-day average in April.

“If you level off incentives [and] leasing and bring inventories into line, then most likely you have some sort of modest decline in new-vehicle volume,” Jackson said. In 2018, if automakers’ production plans incorporate raising incentives even higher, “I don’t know whether that’s doable or not,” he said.

Sonic and Penske Automotive Group Inc. said incentives softened on luxury vehicles in January and February, which slowed those sales.

But in March, incentives “went berserk,” said Sonic’s Dyke. He expects incentives to fluctuate all year, with the next spike in June.

“The incentives are all over the board,” and will remain so, he said. “I expect to see a topsy-turvy incentive environment.” Most automakers “have a good amount of supply so they will continue to push incentives on us,” Dyke said.

Penske Automotive Chairman Roger Penske urged automakers to exercise caution on incentives as they approach 10 to 11 percent of sticker prices, “which people say is the top end.”

Lithia Motors Inc. CEO Bryan DeBoer called factory incentive programs stable, but predicted they will accelerate by autumn. Lithia’s new-vehicle inventory fell to a 76-day supply, a two-day decrease from a year earlier. But he offered a defense of the push to keep new-vehicle sales going.

“It starts with that new-car sale,” said DeBoer. New-vehicle operations contribute only a fifth of Lithia’s gross profit, he said. “So it’s a small amount, but that contribution is what generates the trade-ins that generate the service and parts business in both new and used that creates that future opportunity to sell that next vehicle.”

1st quarter at the publics

First-quarter results for publicly traded new-vehicle dealership groups
  Total Change from year earlier
Revenue $5.14 billion 0.40%
Net income $98.1 million 2.30%
Revenue $1.55 billion 0.10%
Net income $34 million 9.70%
Group 1
Revenue $2.52 billion –3.4%
Net income $33.9 million –1%
Revenue $2.24 billion 13%
Net income $50.7 million 26%
Revenue $5.08 billion 5.30%
Net income $83 million 3.50%
Revenue $2.29 billion 2.40%
Net loss –$541,000 N/A
Source: Companies

Inventory issues

Earl Hesterberg, CEO of Group 1 Automotive, said the retailer’s new-vehicle inventory at its U.S. stores was 86 days, consistent with the year earlier but far too high. Domestics were the biggest challenge, he said. Group 1’s General Motors, FCA and Ford inventories were all more than 100 days.

Craig Monaghan, CEO of Asbury Automotive Group Inc., said, “The inventory stacks up in stores, and there is a lot of pressure on stores to move that inventory.”

Asbury’s new-vehicle inventory jumped to a 74-day supply, a 13-day increase from a year earlier. Its used-vehicle supply rose two days to 32. Asbury’s new-vehicle levels are higher than the company would like, but manageable, executives said.

“The fundamental issue is there’s too much production,” Monaghan said. That leads to aggressive sales targets that demoralize employees who don’t achieve them, turns off customers who see various spreads on prices in one month and in turn, devalues the franchise, he said.

It won’t last forever, he said. When new-vehicle production aligns with demand, “some of this will stabilize,” Monaghan said. “In the meantime, we’ve got to manage through it, and we’ve got to do the best we can on a store-to-store basis.”

Penske said automakers must balance supply and demand with reasonable incentives to support residual values so that dealers have a competitive lease rate.

Pete DeLongchamps, vice president at Group 1 Automotive, echoed that.

“Leasing provides a way to make monthly payments affordable and with [average transaction prices] rising it becomes even more important,” DeLongchamps wrote in an email. “As long as the OEMs keep proper supply in check, theoretically residual values will remain within the range of their initial projections.”

Dyke: Incentives “went berserk” in March.

But Sonic’s Dyke said BMW is encouraging its dealers to do fewer leases and more sales, a feat he says is nearly impossible without losing volume because consumers can get into a lease for a lower monthly payment than with a sale. 

“It’s a conundrum right now and something we have to figure out,” said Dyke. “The residual value is going to have to go up so [the consumer] doesn’t take it in the shorts at the end of the lease term.” 

Penske noted that Jackson had said that lease rates were “getting up to the penthouse,” adding, “he might be right.” 

The number of vehicles coming off lease might pressure some automakers to discourage leases. But Penske said consumers still have a strong appetite for them. Many dealers like leases because off-lease vehicles are desirable used vehicles. 

Penske agreed with Jackson’s overall concerns, but he added: “We have to look at our model.” 

His company can draw revenue from its commercial truck dealerships, truck leasing company, international dealerships and now used-only stores, Penske said. The diversification can offset headwinds in the new-vehicle retail market. 

“I’m looking at every lever I can pull,” said Penske. “We’ll see at the end of the race who gets the trophy.”

Laurence Iliff contributed to this report.

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