The automotive industry remains critical to the UK economy. However it is difficult to find another industry facing so much uncertainty as a result of:
- Brexit – in the UK we manufacture around 1.7 million vehicles per annum, of which c.75% are exported. Local supply content in this manufacturing process ranges from 25% to 45%. As a result, the industry relies on the free movement of goods across borders
- Disruptive technologies - there is talk of electrification and driverless technology. How will these technologies impact the UK industry in the near to medium-term?
- Dieselgate – what impact does this have on the trust and confidence of the UK consumer and how will this impact diesel or wider vehicle sales?
- Personal Contract Purchase (PCP) – can the PCP bubble sustain further UK growth?
The macro environmental concerns are leading to falling consumer confidence and as a result, falling registration demands. The Original Equipment Manufacturers (OEM) targets however remain high, further driving the low profitability down to the bottom line of the motor retailer.
Registration data is only one part of the story pointing to the health of the downstream automotive industry. Margins and the influence of bonuses from the vehicle manufacturers significantly impact retailers and their profitability. Dealerships need to meet their sales targets in order to achieve their performance bonuses, and currently the targets are too high and bonuses are being missed. What really drives performance is having realistic targets that reflect current market conditions and adapt to the economic environment.
Unfortunately, it is not as simple as adjusting the targets overnight. OEMs plan their production well in advance and in the case of the UK, right hand drive creates an extra challenge where true demand is falling, given their restricted market. If the product is produced for the UK market, the ability for reallocation is limited. The vehicles are likely to be unsold and lose value.
How has this uncertainty impacted the sector?
Despite the expected loss of consumer confidence, at the end of Q1 2017 there was optimism around the new passenger car registration data and no-one was prepared to look ahead to the gathering pressure in the market. Used vehicles were performing strongly and most retailers felt positive.
At the end of Q2, there were signs that the expected volume slow-down was starting and the registration data was showing a decline over 2016, although the percentage fall was only 1.33% compared to June 2017. This still left 2017, as it stood, as the third highest registration volume since 1976, therefore the summer was entered with cautious optimism.
Q3 registrations were challenging. The cumulative decline of the market has held at only 3.9%, coming at a cost to a number of motor retail groups. The decline is based on the macro climate and the impact of the bonus and incentive monies. Both factors are largely outside the control of a motor retail dealer group, as Pendragon spelled out during their profits warning issued to the City towards the end of October1.
One strong point made by Trevor Finn, Pendragon CEO, was that registration volumes are primarily judged on quarterly cycles, and “it’s not really until the end of the period that you ever get a really clear sense of where volumes are going to land”2.
This implies that bonus and incentive monies have not been aligned to declining volumes, adjusted via the usual ‘target’ mechanism, and therefore margins are seriously impacted. Finn went on to stress the impact new vehicle volume challenges are having on used vehicle performance, which is now a real factor of concern as motor retailers have registered vehicles from their new targets and brought them in to the used environment. When there ends up being a surplus of used product, and more cautious demand, margins are squeezed. Some (the minority) OEMs appear to have dealt with this more quickly than others, but it is becoming evident that there is a clear gap appearing between those retailers who are coping and those who are now finding life tougher.
The challenging years of 2007 and 2008 proved that all is not doom and gloom when the tide turns. Motor retailers steered a course through the issues with OEM support. Whilst there were major challenges at OEM level, they relate to production and surplus capacity globally. Currently there are demand-side challenges, but these can be tackled through positive collaboration between the OEMs and motor retailers. This could be achieved by setting realistic targets based on run-rate demand and ensuring both new and used vehicles can be retailed at sensible margins, whilst satisfying customer needs and keeping production at a profitable level.
One leading motor retail analyst has expressed surprise at the 20% fall in used vehicle margins stated in the Pendragon profits warning – “we would not expect to see a gross profit drop of this nature across the sector during Q3”. Despite the fall in used margins, Pendragon also re-affirmed their focus on growth in used cars and noted that Q4 was turning around.
The view that Pendragon’s results were potentially anomalous is supported by the Q3 results released by Lookers in early November3. As the competitor for the title of the UK’s largest dealer group, they reported a 10% increase of new car revenue, a 25% increase in used car revenue and an 11% increase in after-sales revenue. Lookers chief executive, Andy Bruce stated that OEMs “recognised the more difficult trading environment and are taking pragmatic and supportive actions such as reducing targets, increasing incentives and helping us to reduce operating costs”.
AutoTrader have recently released a strong half-yearly results with a 7% increase in revenue4. They highlight that with over 80% of their revenue coming from dealers rather than private sellers, they have a unique view on the market. Meanwhile acknowledging that the used car market is flat but the results highlight “the increased focus retailers are putting on the larger opportunity they see in used cars”.
The motor retail industry remains robust and there will always be positives and negatives in performance
Pendragon is high profile and gets attention because it is a listed company. Well run businesses with strong OEM relationships, and more importantly, realistic targets, continue to enjoy strong profitability. These issues affect a cross-section of brands, including those facing tough times.
Volumes will continue to decline while the macroeconomic conditions are stable. We will also see strong retailers adapting their business model to cope with the circumstances. When the volume alignment comes through at OEM production level, there is more scope to reshape vehicle retailing and registration models. As another key component to retailers performance, aftersales is benefitting from the recent volume increases in registrations. Aftersales will continue to perform strongly as evidenced by Pendragon announcing a 3% rise in their used vehicle gross profit on a like-for-like basis, meaning that dealers can still rely on used car sales and maintenance to help bolster their financial performance.
Ultimately, there will be reductions in the size of the motor retailer networks, but this takes time and careful consideration to implement. Weaker retailers with lesser cash resources will undoubtedly find life too hard going and disappear by natural attrition, however, M&A activity in the sector is relatively buoyant which could act as a safety net. Cash constraints at today’s date are a major warning sign – even more so if they are driven by losses. The more savvy retailers are well-prepared for more interesting times, but the production/demand conundrum remains an influence over which they have very little control.
- Interim Statement and Strategy Update, Pendragon PLC, October 2017
- Pendragon car dealership shares drop on profit warning, Financial TImes, October 2017
- Interim Results: Half Year Ended 30 June 2017, Lookers PLC, June 2017
- Auto Trader Half Year Results for the six months ended 30 September 2017, Auto Trader Group PLC, November 2017