Send us a LetterHave an opinion about this story? Click here to submit a Letter to the Editor, and we may publish it in print.
Dealers knew low interest rates wouldn’t last forever — and the day of reckoning has arrived.
Even with automaker subsidies, dealership floorplan expenses this year flipped to a cost vs. a revenue item for the first time in nine years as interest rates rose, according to the National Automobile Dealers Association. The swing has dealerships small and large, public and private, exploring ways to mitigate the cost.
“The industry for both the manufacturer and the retailer has had a nirvana period where the cost of capital and the cost of inventory has basically been free. But those days are over. Rates have already risen,” AutoNation CEO Mike Jackson told Automotive News. “So now each retailer has to look at their inventories and say, ‘Wow, does it make sense to carry this much inventory?’ ”
AutoNation’s Mike Jackson: Retailers must reassess how much inventory to carry.
Dealership floorplan, the loans taken out to finance vehicle inventory, has traditionally been a cost. It was only over the last eight years, amid plunging interest rates, that floorplanning became a profit center as automakers continued to provide hefty assistance payments as incentives for stores to buy new vehicles.
But those days are over as interest rates climb.
Through May, the average U.S. dealership paid $61 per new and used vehicle in floorplan expense vs. a gain of $22 the year earlier, according to NADA. Overall floorplan interest expense more than quadrupled to $22,024 on average, compared with a gain of $8,144 in 2017.
The Federal Reserve has raised its benchmark interest rate five times in the past 17 months, including twice this year. The rate is in a range of 1.75 to 2 percent. The Fed has forecast it will raise rates twice more this year and three times in 2019.
After 8 years, a floorplan flip
NADA’s senior economist, Patrick Manzi, expects floorplan to become an expense again in 2018. Floorplan became a profit center as interest rates dipped after the Great Recession. Below is the average amount made per dealership off floorplan.
The swing is showing up in the financial results for all six public dealership groups. In the second quarter, floorplan interest expense jumped for the six, in some cases by double-digit percentages.
Executives at all of the public groups say they plan to shrink inventories. Lithia Motors, for example, said in July that it has put inventory reduction plans in place at 50 of its stores.
Penske Automotive Group says the interest rate hikes in the U.S. have led to $7 million to $8 million in additional interest costs, mostly driven by floorplan.
With a 72-day supply of new vehicles, the retailer can gain “tremendous” savings by lowering that by one or two days, CEO Roger Penske told Automotive News.
“We’re pushing back with all the OEMs on taking inventory when our inventory’s too high,” Penske said. “We’ve got to be much better at ordering the right vehicles and turning our inventory.”
With the rate hikes, floorplan will return to a traditional expense going forward, said Patrick Manzi, senior economist for NADA.
By year end, “unless manufacturers increase the amount they’re paying to dealers, the interest expense will outweigh the floorplan rebate,” Manzi said.
Floorplanning as a dealership profit center goes back at least to 2009, according to NADA. In 2010, dealerships made an average of $2,355. That number then climbed every year before peaking in 2015 at $109,497. In 2016, the average dealership made $85,855 before the benefit plummeted 80 percent to $17,083 in 2017.
Even though dealers knew low interest rates weren’t permanent, they now must absorb an expense that most haven’t been required to pay in nearly a decade. So, what’s a dealer to do?
Scrutinize inventory and expense structure, Manzi and dealership accountants say.
Robert Davis, partner at accounting firm Dixon Hughes Goodman, said he has seen dealers embrace such scrutiny more in the past two years than the previous three or four.
But he warned that dealers must manage the shift carefully — turning inventory faster could mean accepting a lower price and thus lower gross profit on the vehicle, even if only by a few dollars.
Dealers also should pay close attention to their new-vehicle orders, Manzi said. “They want to make sure that they’re only stocking things that they can sell,” he said.
New-vehicle days’ supply has steadily increased since 2015, that peak year for floorplan profits, according to the Automotive News Data Center. But U.S. light-vehicle sales dipped 1.8 percent in 2017, showing that dealers are “not reducing those inventory levels as fast as some might want to,” said Jodi Kippe, managing partner for the retail dealer services group at accounting firm Crowe.
But as dealerships lower inventory, it could put them in the position of missing some automaker subsidies. That assistance is determined in many cases by the monthly volume a dealership buys, dealership accountants and NADA said.
“They’re not buying as many cars from the automakers and not getting as much interest assistance,” Kippe said. “It’s an increase in expense and less interest assistance coming from the automakers.”
To speed payments and avoid paying interest on vehicles already off their lots, more dealers are adopting electronic contracting, Kippe said.
That reduces the contract-in-transit time, so the dealership gets the cash to pay floorplan cost more quickly.
Some dealership groups, such as Group 1 Automotive, also have swaps in place to guard against fluctuating interest rates. A swap agreement ensures the dealership only pays an agreed-upon fixed rate, even if the benchmark interest rate exceeds it.
Group 1 offset some floorplan interest expense by cutting 5,000 vehicles from inventory through June compared with the year earlier, added Daryl Kenningham, president of U.S. operations.
For Group 1 — and all retailers — “rising interest rates force us to adjust,” Kenningham said. “That’s for sure.”
Melissa Burden contributed to this report.