Leading publishers of Blue-Sky multiples agree that buyers have shifted the application of Blue-Sky multiples from historical adjusted profits from the last twelve months to a three-year average of adjusted profits as a predictor of future earnings. For 2022, this approach incorporates two out of three years of outperformance. The decreased supply of new vehicles resulting from the pandemic and other supply chain issues coupled with strong consumer demand has created the best environment for retailing new and used vehicles that we have encountered. Year-to-date 2022, we have seen new record profit months. But is this level of net profit truly sustainable for the long term? I ask this question considering the following current conditions:

• FTC New Safeguards Rule – Most of the substantive provisions of the new Safeguards Rule will go into effect Dec. 9, 2022. NADA had estimated that compliance will average $293,000 for startup costs and another $275,000 to maintain annually. While these estimates have proven to be high in most cases, the cost of compliance will be significant. For most dealers, this is a cost that cannot be fully offset by reductions in other areas.
  
  
• Interest rate increases – While most dealers are still turning their inventories at a rapid pace, the interest rate increases already seen in 2022 and those expected to come may not have a significant impact on floorplan interest expense. But what about the effect the interest rate increases have on consumers’ ability to purchase vehicles? Loan terms of 72 and 84 months have become more commonplace, and monthly payments are at an all-time high. If consumers are already at the maximum length and payment, and interest rates available to the consumer rise, they will be forced to finance a lower amount. What impact will this have on dealers’ ability to maintain the exceptional turn ratios keeping interest expense down? What impact will this have on dealers’ gross profits and back-end profits?
  
  
• Inflation – The annual inflation rate in the U.S. was 8.1% in August 2022. With used cars being the component with the highest level of price inflation, car dealers have benefited from inflation. However, used car prices are declining. Experts expect used car prices to continue to decline through the end of the year. Considering the quick turn ratio mentioned above, dealers may now feel the effects of the decline in their used inventory values. Used write-downs may be stronger in 2022 than in pre-pandemic years due to dealers having larger used car inventories to offset the shortage in new inventories. Compounding the dealers’ dilemma with inflation is that expenses are sure to increase as experts expect only a gradual ease in overall inflation.

So why do I raise the red flag on predicting future profits? The reason is two-fold. If you are a dealer with excess cash looking to buy a dealership, you may want to consider these factors when projecting sustainable profits for the Blue-Sky offer. In addition, now is the time to develop your contingency plan for when and if these factors start impacting your net profits.