Automotive review

The automotive upstream industry, manufacturing, is global, using just-in-time supply chain processes to source components for vehicles across continents and reduce working capital and inventory to a minimum. This protocol curtails trapped cash in the business and maintains lower costs across the production process. COVID-19 has directly impacted the shortage of semiconductors and other vehicle component raw materials. 

Downstream, dealers and customer-facing companies have also experienced rapid change, being forced to retail online. To manage the challenges it faced, the upstream sector has reviewed the supply chain and production processes to cope with the closure of factories and reduce costs in order to enhance earnings.

How did automotive OEM companies cope with coronavirus?

The profits of most major original equipment manufacturers (OEMs) were only lightly impacted by the difficulties of the last 18 months.  

There was also limited impact on the supply chain, with small amounts of disruption, even in China, where coronavirus first appeared.  However, by mid Q1, this changed, and factories closed as lockdowns were imposed around the world. By Q2 2020, profits were falling dramatically and, in some cases, tipped into significant losses. To calculate this, we've used normalised earnings as this does not account for any exceptional items that may have affected profits.

General Motors, Toyota, Kia, Tesla and Hyundai remained in profit in Q2 2020; however, Hyundai went on to make a loss in Q3 2020.

With factories closed and retailing vehicles also on hold, there is little automotive OEM companies could do to avoid impact on their profits: cost reductions were quickly enacted, and staff put on furlough where possible. The specific impact of these problems, however, did vary between companies.

There are still challenges ahead

It's still important to note that although all automotive OEM companies performed well in Q1 2021, there are are some remaining causes for concern. In addition to semi-conductors, there are shortages in raw materials such as natural rubber - costs for these materials, as well as shipping and logistics, are also rising. 

The big risk for the remainder of this year is the semi-conductor shortage. Some OEMs have indicated that it will continue into 2022.

With little respite from this and other issues in the supply chain there is a risk that profits might once again come under pressure in the remainder of 2021 and early 2022. This will filter up from the OEM's tier one-four parts' suppliers to distribution and retail. 

This is becoming apparent as the shortage of new vehicles is starting to impact the used car market.

If you would like more information on what's happening in the automotive industry get in touch with Owen Edwards.

At the start of the first lockdown, we anticipated a high rate of insolvencies in H2 2020. This outcome was mitigated by the government's actions to provide financial support to companies throughout this period.

The extension of the furlough scheme supported job security until September 2021. With better than expected liquidity in the economy, this has enabled some companies to make new acquisitions.

Additionally, rumours that the government might have increased capital gains tax (CGT) at the March 2021 Budget — to bring down the public sector debt of  £2.13 trillion — encouraged many company owners to accelerate plans to dispose of their business before this happened. Although Budget 2021 did not actually feature an increase in CGT, there is growing speculation that it might occur in the future.

At both ends of the spectrum – the upstream (manufacturing) and the downstream (customer facing service companies) – consolidation is taking place, exacerbated by wide-ranging changes in the automotive market.

Electric vehicles

Further harsher financial penalties for missing emission regulations are forcing automotive original equipment Manufacturer (OEM) companies into heavy investment in new power trains and light weighting to reduce the emissions of their new vehicles.

This investment impacted their profits and, in turn, forced them to reduce costs and restructure.

Consolidation and the benefit of economies of scale, as seen in PSA’s acquisition of Vauxhall/Opel can provide some cost savings. Some consolidation is also expected in the coming year as the automotive OEM companies look for a route to generate greater market share and lower costs.

We expect further consolidation in the downstream sector in several areas. Dealer groups will continue to grow in size. Meanwhile, used car supermarkets are set to increase their vertical integration into other areas of the market: vehicle remarketing (Cazoo acquiring Smartfleet) and car subscription (Cazoo acquiring Dover).

We believe that leasing and fleet companies will also consider strengthening their position through consolidation in order to gain economies of scale, as well as through the provision of additional services, such as the move into value-added services: e.g., Mobility-as-a-Service.

Among the dealers, we can see that consolidation has continued over several years. The number of dealer outlets has shown a gradual decline of 6.5% over the last five years. The franchise outlet for European volume brands have lost c.14% of their franchise outlet over the last 5 years. Citroen has seen a reduction of 26.2% of their outlets over the last 5 years, and Vauxhall has seen a decline of 20.3% over the last 5 years.

_{Graph: Total UK Franchise dealer outlets – Main outlets}

If we go back to the financial global recession of 2007, acquisitions in 2008 among car dealers and vehicle repair companies dropped, with a strong bounce back in activity in 2009, possibly because of pent-up demand.

_{Graph: Year motor retail acquisition 2007 to 2020} 

Valuation of automotive dealerships

Most dealerships are asset-rich and could be valued in different ways. The approach to general retail assets is a valuation of enterprise value (EV) to earnings before Interest tax depreciation and amortisation (EBITDA). With the large number of assets held by a motor retailer – including freehold property, new and used vehicles and spare parts inventory. So, it's important to ensure full shareholder value is achieved.

Dealers should be valued as follows: net asset value, plus a goodwill multiple of EBITDA. This takes into consideration both the asset-value of the business and its profitability.

It should be noted that the quoted Plc companies on the London Stock Exchange are not valued by the same method because they have a quoted market capitalisation — therefore, adding net debt equates to EV, which is then divided by EBITDA. Also, many equity funds need to hold shares in certain market sectors to maintain balance in their portfolio.

Motor retailers are in the general retail sector. Index tracker funds and some portfolio fund managers will have to allocate a proportion of their fund to general retail and, within this sector, the standard valuation process is either EV/EBITDA or price earnings ratio. Recently, Inchcape Plc – a distribution company – has moved from the general retail sector to support services.

In summary, non-quoted motor retail companies are valued on a net asset + EBITDA goodwill bases.

Guaranteed vehicle buy-backs, correctly-valued used vehicle and parts stocks, onerous employment contracts, and a strong and healthy relationship with the OEMs.

This list is not exhaustive, but it does provide an indication of the qualities in a business that can command a higher price.

When buying, selling, or consolidating a business, it's good practice to engage a professional adviser early in the process, as it's difficult to negotiate the price upwards from an indicative base. There are also many pitfalls throughout the process, which an adviser can help sellers avoid.

If you would like more information about the auto retail sector, assistance in the disposal of your business, or purchase of incremental assets, get in touch with Owen Edwards.