AutoCanada
With AutoCanda currently undergoing a ‘Strategic Review”, I wanted to put down some thoughts about the company’s strategy and its competitive advantages. I will also send these to the Special Committee of the Board that is currently looking at Strategic Alternatives
Description: AutoCanada owns 54 automobile dealerships in Canada and has a total of 4,200 employees. Brands include the various Chrysler Brands (Chrysler, Dodge, Jeep, Ram), FIAT, the various General Motors brands (GMC, Chevrolet, Cadillac , Buick), Infinity, Nissan, Hyundai, Subaru, Mitsubishi, Audi, Volkswagen, KIA, BMW and MINI, Toyota and Lincoln. Revenue categories include new car sales, used car sales, finance and insurance and parts/service. Almost half of its revenues are from Fiat Chrysler (46%) 11% from Nissan/Infiniti, 10% from Volkswagen/Audi, 10% from BMW/MINI, 9% from General Motors, 7% Hyundai and 7% others. 45% of revenue is from dealerships in Alberta with a further 20% in B.C. They lease about half of their locations and own the others. These figures exclude the Q2 2018 acquisition of 8 dealerships in the Chicago metro area plus a large autoplex also in Illinois.
Growth Strategy: AutoCanada’s strategy has been growth-by-acquisition of additional dealerships.
Profitability of the Industry: Auto dealerships certainly appear to be profitable and prosperous businesses. In large cities there are always many auto dealerships and they almost always have bright updated looking buildings. In small towns, auto dealerships are often (or always) among the most prosperous looking businesses. It seems to me that if auto dealerships were not profitable businesses it would not have been possible to get the dealers to spend money on what appears to be relatively frequent and costly upgrades to their buildings and lots. However, the need to make these investments to keep the dealerships looking modern and fresh is a negative aspect of the business.
Competitive Environment: Here, there are pluses and minuses.
On the minus side, auto dealers sell identical products as other dealers selling the same brand. To a certain degree this fosters an environment of competing largely on price, and that’s not a recipe for high profits in any business. Dealers battle this tendency to some degree by making their prices somewhat opaque. The price that any individual customer pays is usually negotiated. This makes it somewhat harder to comparison shop for the lowest price.
On the plus side, auto dealers are somewhat protected from very local competition since the manufactures will not locate a competing dealer with the same brands unreasonably close to an existing dealer. Therefore some level of exclusive territory is provided although certainly the exclusive territory would not tend to be as large as an existing dealer would prefer. Most customers would prefer to purchase from a dealer located most conveniently to their home or work location.
Overall, I believe that the profitability of the auto dealer business is good and that AutoCanada’s strategy of growth by acquisition in this industry has merit provided that it does not over-pay to acquire dealerships.
Synergies:
AutoCanada’s business model depends on its ability to add profits to acquired dealers through some sort of synergies and economies of scale.
One possible economy of scale would be volume-discounts from the manufacturers. However, I understood from reading Berkshire Hathaway’s annual report that its group of auto dealerships does not enjoy such discounts. My understanding is that there are volume discounts / incentives at the individual dealership level but that these do not apply across multiple dealerships.
There would be some synergies related to financing multiple dealerships. However, this benefit is muted because the manufacturers apparently require minimum working capital levels be kept at each dealership rather than on a consolidated basis.
There would also be synergies in negotiating the highest commissions on selling financing adn warranty products.
Regarding marketing, there may be little in the way of synergies. National brand advertising is done by the manufacturing. Auto dealer advertising tends very much to be specific to individual dealerships. This advertising usually involves local newspapers and local radio stations. There may be some ability get volume discounts from national newspaper and radio chains but overall the opportunity for savings may be modest due to the local and dealer-specific nature of the advertising.
Regarding administration and management there may be some synergies involving computer systems and the sharing of best practices. On the other hand competing dealers often have an entrepreneurial owner minding the shop which can lead to a sharper focus on cost management for those competitors.
Repeat Business: All else equal, a business with frequent repeat business from the same customers tends to be more profitable. Unfortunately, while some customers may purchase or lease a new car from the same dealer every few years, that is probably much more the exception than the norm. In my own case between my wife and I, we have purchased just four new vehicles and two used vehicles going back 30 years three of which we still own. These six purchases were made at five different dealerships plus one used-car lot. Given that many people keep a new vehicle for approximately a decade, and given changes in tastes and needs, and given the tendency to relocate, and given the tendency to shop based on price, there is often little likelihood of purchasing a new car from the same dealer multiple times or even more than once.
On the plus side, once a new car is sold, there is often repoeat business in terms of servicing including warranty and recall work (both of which are paid for by the manufactures albeit at a lower than normal hourly labour rate).
Return on Equity: On an adjusted earnings basis, AutoCanada’s return on equity in the four years from 2011 through 2014 was very attractive as it averaged over 19%. And this was achieved despite the large goodwill premiums that AutoCanada had paid in acquiring dealerships. However, mainly due to the energy-related recession in western Canada the ROE was barely adequate at about 9% each year in 2015 through 2017. And Q1 2018 saw adjusted profits per share (after deducting a gain on an asset sale) decline by 86% by my calculations. It remains to be seen if AutoCanada can return to an attractive ROE level.
Strategic Alternatives: This could involve selling the entire company. Given recent weaker results it seems unlikely that this could be done at much or any gain in the share price. Some individual dealerships could likely be sold for gains to other groups that already own multiple dealerships. These groups are privately owned as opposed to being publicly traded. But such sales would lead to revenue and profit per share declines in subsequent years.
Conclusion: Management and particularly the Board are in the best position to judge whether selling some dealerships or even the entire company would benefit share holders.