A Call for Caution As Dealers Return to Auctions

May 14, 2020

It’s good to feel good about the current state of the retail used vehicle market.

Retail sales are off last year’s totals by single-digit percentages, up significantly from the near-standstill that gripped much of the country two months ago. While the growth curve of the retail rebound has flattened, it’s not yet falling off—a good sign.

The current circumstances have some dealers feeling bullish as they return to wholesale auctions to acquire inventory and prep for what many believe is the beginning of a retail recovery.

But I would suggest dealers proceed with caution for a few reasons.

First, I believe that a sizable share of the recent retail sales owes to $1,200 and $2,400 federal stimulus checks arriving in bank accounts and mailboxes across the country. The retail rise doesn’t owe to an improvement in the fundamentals of the retail market, particularly when we know that more than 30 million Americans are out of work and seeking unemployment benefits.

Second, I’m concerned that while some of the recently unemployed will be coming back to work as more states ease social distancing restrictions, their rate of return won’t come close to how quickly they lost their jobs. Similarly, I have doubts that household earnings and spending power, which have taken a dramatic dive for many, won’t recover as fast as they diminished.

Third, there’s a very real possibility that many of the jobs that went away in recent weeks won’t be coming back. Retailers everywhere, including dealers, are rethinking how they provide their services, and how they can do more with less in an effort to maintain, if not restore, profitability.

All this isn’t to say that dealers shouldn’t be returning to auction and looking for opportunity. In fact, there is what I consider to be an unprecedented, if short-lived, opportunity in the wholesale market right now—the difference between current wholesale and retail prices. Since the pandemic started, wholesale values have dropped an average of 12 percent, while prevailing retail prices have dropped by 2 percent to 3 percent. If dealers are evaluating wholesale vehicles with an understanding of their current retail asking prices, they’ll find vehicles that offer gross profit opportunity.

Still, the current conditions, and the concerns about the resilience of retail demand in the weeks ahead, suggest dealers should exercise prudence as they acquire additional inventory. I’ve been advising dealers to consider two best practices:

Tie your inventory levels to recent retail sales. Prior to the pandemic, I advocated that dealers stock their inventories to achieve a balance between their rolling 30-day total of retail sales and their current inventory. If the rolling 30-day total shows you retailed 40 vehicles, you should have 40 in stock. In the current situation, however, I’m encouraging dealers to stock with a leaner, lighter hand, and maintain their inventory levels between 60 percent and 80 percent of their rolling 30-day total of retail sales. This adjustment is necessary, I believe, to ensure that dealers aren’t over-loaded with inventory if the retail market sputters or stops in the weeks ahead.

Recognize the risky cars. Late model used vehicles typically represent the most expensive investments in dealer inventories, and these vehicles compete most directly with comparable new vehicles. Given these circumstances, and a market where factories are offering ever-more attractive incentives to move new vehicles, late model used vehicles represent far riskier investments for dealers than usual. I’ve been urging dealers to be careful when they acquire these vehicles, particularly 2019 model-year units. If you know you need them, and believe the market will buy them, I’m advising dealers to price them to retail quickly to mitigate the investment risk.

My overall point here is that while the current market offers opportunity and may signal market strength in the weeks and months ahead, no one knows how things will play out. With such uncertainty, it seems wise for dealers to proceed with care and caution as they return to auctions to acquire used vehicles.