Starting in the mid-1990s, some of America's biggest car dealer chains went public. And for a while, the likes of AutoNation (AN), Asbury Automotive Group (ABG), and Lithia Motors (LAD) did investors proud—with the best performers doubling their value between 2003 and the middle of last year.
Even when car sales began to stall in mid-2006, Wall Street didn't shout "Sell!" After all, the chains had sold investors on the notion that they could thrive during a downturn by selling lots of high-margin used cars and raking in millions servicing vehicles people were keeping.
It hasn't quite panned out that way. Yes, the dealers mostly continue to make money. But their stocks largely have been lemons: Of the six publicly traded companies, all have watched stock prices plunge 24% or more in the past year. Most of the dealers' profits are slipping. "This is the first major downturn since they have gone public," says Standard & Poor's (MHP) equity analyst Efraim Levy. "Let's see them perform in a downturn and we'll believe [their sales pitch]."
It won't be so easy. Tight credit and $4-a-gallon gasoline have overturned many of the rosy assumptions of yesteryear. Consumers are buying smaller vehicles, which generate less profit. And to buy them, Americans are trading in gas-sucking SUVs that are harder to sell than snow tires in August. Earl Hesterberg, CEO of Group 1 Automotive chain, says his dealerships have cut gross profits on used trucks by nearly a third. The vehicles are moving, but used-car profits fell 6% in the first quarter, and overall earnings dropped slightly, to $16.4 million, on $1.5 billion in revenue. A similar story is unfolding at other publicly traded dealers.
Banks' hesitation to lend isn't making life for dealers any easier. AmeriCredit (ACF) says it has recently cut auto lending by 60%; others are scaling back, too. So even when dealers find buyers for used vehicles, they may not be able to find them a loan. "Last year we were stronger selling to subprime borrowers," says Asbury President and CEO Charles R. Oglesby. "Lender policies were much looser then, and we took advantage of it." Those days are gone.
As for the argument that dealers would make lots of money repairing the cars people hang on to in hard times: That business is growing, but not enough to offset slipping revenues elsewhere. On the one hand, dealers have successfully stolen business from oil-change and repair chains. On the other, cars are now better made, and with some manufacturers offering extended warranties, dealers make less on the work.
When times were good, the big car dealer chains went on a shopping spree, snapping up scores of rivals—and paying big premiums to get them. Under pressure from carmakers to spruce up their stores, many dealers spent millions on fancy facades and luxe showrooms. Now, with sales slumping, interest payments are starting to crimp profits, and the cost-cutting has begun. At Lithia, Chairman Sid DeBoer says he's saved $500,000 a month by cutting staff. Trading high rent for cheaper mortgage payments, Asbury Automotive has bought back the real estate that sits under a quarter of its dealerships.
Analysts say the stocks are so beaten down that some are a good buy. And profits should improve as the chains cut costs. But much depends on what happens to new car sales—and with credit still tight, many industry watchers are predicting a prolonged drought.