Auto Dealers: 7 Narrow-Moat Companies to Know (2024)

Auto dealers are on track to recover from 2020—and new verticals await while consolidation continues.

The auto dealer industry is highly fragmented. Although we cover all six publicly traded new-vehicle franchise dealers, they sell only about 6% of annual US new light vehicles. The sector remains primarily one of entrepreneurs rather than large corporations.

Public dealers have seen a modest boost in share since 2020, while the top 10 firms’ share now exceeds 8% from about 6%-7% at the turn of the century. We expect continued gradual consolidation via acquisitions and from open points awarded to the largest firms because they can best fund automakers’ expensive store imaging requirements.

Still, a highly fragmented sector means a long growth runway for the largest players via organic growth, acquisitions, and expansion into new verticals.

3 Key Themes Driving the Auto Dealer Industry

We see three themes at the center of the auto dealer industry:

1. Profits are coming down from chip shortage highs. Before 2020, a strong operating margin level, including floor plan interest (interest cost to buy inventory), was around 4%. Covid-19 and the chip shortage decimated new-vehicle inventory and gave dealers a surge in new-vehicle pricing power through 2022, sending margins to levels that would have been absurd to model before 2020 (7%-8% EBIT). US new light-vehicle inventory remains below prepandemic levels of 3.5 million-4 million units. The pricing power surge is over as inventory has been rising this year, but operating margins may stay higher than prepandemic levels, especially with dealers making permanent headcount reductions in 2020.

2. The auto dealer industry isn’t as cyclical as you may think. Dealers do more than sell new vehicles, though new vehicles are the foundation for other segments. They sell used vehicles of any brand, not just for their new-vehicle franchise brand. A new-vehicle customer may have a trade-in that the dealer can then possibly sell as a used vehicle. Normally, used vehicles bring higher gross margins than new vehicles, but for now that has reversed, with the chip shortage elevating used-vehicle procurement costs. A buyer must have a new vehicle serviced at the dealer for warranty work, which along with finance and insurance products at the point of sale brings lucrative profits.

3. The sector is gradually consolidating. As the US urbanized and the Detroit Three lost their dominance, larger dealers have needed to serve more people in order to do well. The sector has consolidated over decades, as some have exited the industry due to insufficient throughput (volume per store), expensive store imaging requirements, and automaker bonus payouts that can be too hard to reach. The sector has seen a two-thirds reduction since 1950, but the biggest dealers are well positioned to keep consolidating via acquisitions while receiving new franchises (called open points) from the automakers.

Our Outlook: New and Used Vehicles Still Recovering From 2020

At just under 3 million, US light-vehicle inventory is not quite back to where it will likely settle postpandemic.

Low inventory, along with leasing still below 2019 levels, gives reason to think new-vehicle sales will rise in the next few years, though not rapidly. Many consumers who bought in 2020-23 during poor availability may not have bought the exact vehicle they wanted, so they could return to the market early.

Still, much higher interest rates than recent years and less supply mean higher prices are holding some consumers back.

As of first-quarter 2024, average interest rates for vehicle loans are markedly higher than they were in first-quarter 2021: 63% higher for new vehicles and about 36% higher for used vehicles.

This sticker shock has led many used-vehicle customers to delay purchases altogether (according to CarMax KMX), while some new-vehicle buyers are trading down to compact cars.

A few interest-rate cuts would help the auto market, especially the used-vehicle market. Even many future increases aggregating over 500 basis points would mean less than $100 a month increase in the monthly payment for new and used loans.

In terms of new verticals, three of the dealers (AutoNation AN, Penske PAG, and Sonic SAH) have launched their own used-vehicle stores, all under separate brands. Asbury ABG and Lithia LAD have also done these in the past but abandoned the effort for various reasons.

Other examples of diversification into new verticals include:

• Lithia this year bought a stake in vehicle fleet manager Wheels and is expanding its own captive finance arm. The firm has also moved into selling RVs and expanded into Canada and the UK.
• AutoNation also has its own captive finance arm and said in April that the loans it writes have about 2.5 times the profit (over the life of the loan) of a third-party loan it arranges in store. AutoNation also signed a nonexclusive robotaxi service agreement with Waymo in 2017.
• CarMax Auto Finance’s $17 billion-plus loan receivables book adds about 200-250 basis points of EBIT margin in a typical quarter.
• Penske has nearly 50 truck stores.
• Sonic has added Harley-Davidson motorcycle dealerships and power sports.

7 Main Players in the Auto Dealer Industry

Of the seven firms that we cover in the dealer space, six are franchise new-vehicle retailers that also sell used vehicles, and one only sells used vehicles (CarMax).

All seven firms have a narrow economic moat, which is owed to the cost advantage and intangible asset moat source. Lithia also has the efficient scale moat source due to its ownership of stores in smaller cities, where it can be the only store for a brand for miles.