Here is the complete transcript
Todd Sullivan: Wilbur Ross said recently he didn’t see current pressures on the US consumer ebbing until the end of next year, how do you feel about that?
Mike Jackson: You know it’s hard to say when exactly pressures are going to ease but sometime into 09, certainly no time into 08. The key thing we are watching for is stabilization in housing and we need the price of housing to stop going to down, that would be the first sign of stabilization and that will begin to give the consumer some sense of confidence about their situation. We see some of that in California already because California was the first state that went into the downward spiral and other states came much later. So yes, it’s probably sometime in 09.
Todd Sullivan: The Kiplinger Report estimates that about 1,200 dealerships across the US are going to close this year, mostly domestic brands, do you see that as an accurate assessment or do you see more than the 1,200?
Mike Jackson: I think it could well be more as we’ve hit a tipping point on sustainability. It’s not just going to be small ones, its going to be big ones also. The retail distribution system was never rationalized and the domestic share moved from 70% to 50%, if you look at the number of dealerships that came out that period of time was very minor vs what was done in the manufacturing side and the white collar side. With any decline in industry value with that overcapacity situation, you’ve hit an inflection point that is going to lead to a rapid decline in the number of dealerships out there, particularly domestic.
The situation was sustained with a bond of loyalty that went just beyond just economics with a resilient business model. But that bond has been broken and the business model cannot handle these types of declines with that type of overcapacity. I think its hit an inflection point and you’re going to see massive amounts of automotive real estate be converted over to other business uses. Families that have been in the business 40, 50, 60, and 70 years are going to say “this is it and I’ve had enough, I’m getting out”.
Todd Sullivan: So by default you will be increasing your market share as these close, and it also means there will be properties perhaps on the market at extremely attractive prices. Is the thought process to perhaps grow market share through the acquisition of some of these cheaper properties or to let them go and just let your market share grow through attrition?
Mike Jackson: Yes, we are going to let it grow through attrition. We’ve tried to pre-position our locations to be the best in the market, to be the ones that have great locations and should survive the shakeout, as you say, stronger than when we went into it. But in the mist of it, it’s a very disruptive and difficult environment to do business in, I won’t mislead you on that. We feel we are well positioned and this is something that had to happen, needs to happen, and we should be in a better position when it’s all set and done.
Todd Sullivan: You said recently that you’re going to decrease your exposure to domestic brands (GM (GM), Ford (F)), I think it’s a 29% now to about 20%. Is that mostly going to be done simply because people aren’t buying domestic brands or are you going to divest some of those domestic brands or change them over?
Mike Jackson: It’s definitely a combination Todd. Us divesting a few more marginal stores we have in domestic, and an acceleration in the share shift that is happening for the entire industry from the domestics over to the imports. It’s a combination of our divestiture / acquisition strategy with what’s happening already in the market place.
Todd Sullivan: So in which direction, clearly you won’t be adding domestic dealerships, so which direction do you see yourself going? Would it be more of a Honda / Toyota or a BMW / Mercedes direction? I think BMW (BMW) just actually reported a sales increase earlier this morning (Friday).
Mike Jackson: We really like premium luxury, we’ve bought a lot of BMW/Mercedes stores over the past five years and are definitely on the lookout to acquire more. Whether we will find one at attractive pricing is another story entirely. We like Nissan (NSANY), Toyota (TM) and Honda (HMC). We basically like the thru-put brands in the metro-urban market, we run a high thru-put model to the greatest extent possible. So that’s what we would be looking for. Again, whether we acquire them or not, depends on the pricing. But we have a pretty good position already, we have 10% of the Mercedes market, so that’s a significant position.
Todd Sullivan: You recently announced a cost reduction plan of a $100 million dollars a year and I believe you are halfway there. How confident are you in delivering the extra $50 million throughout the rest of the year?
Mike Jackson: If I wasn’t more that 100% confident I wouldn’t have announced it
Todd Sullivan: Very nice.
Mike Jackson: Well, that’s why it took me six months to announce it. I mean we basically had an internal goal going into ’08. Doing it though, you know to where it didn’t damage the company long term required a lot of effort and a lot of skill. You have to be extremely thoughtful and you may run into some situations you hadn’t anticipated, that means you can’t hit the target. So we are past that point. We got the hard part done.
Todd Sullivan: When you look at the environment right now, there are some real dichotomies out there. You have automakers saying that they are seeing signs of a bottom and that the worst might be over, but you have analysts out there who are lowering some price targets and say from the next 6-8 months things are going to be bad for the auto dealers, like you. There seems to like this contradiction of thought in regards to outlook. What do you say to someone who is an investor with a 2-3 year time frame, who is looking at these 2 areas and is saying I don’t know what I should do? My personal thought is now is when you buy, but there are a lot of people who are unsure.
Mike Jackson: Well, if you look at our performance year to date, we really hit the trifecta as far as cross currents. The housing crisis which we called out years ago as soon as it started and that it would have implications for our industry. We called that out in ’05 and that then rolled into a credit crisis which started again in housing but now has definitely spread to other businesses and to having effects on the marginal buyer not being able to buy an automobile, so that’s affecting volume. We had a spike in May up to $4.00 a gallon for gasoline and we are dealing with a geographic development in Florida and California, being the two worst states.
So just about everything that can go wrong has gone wrong as far as headwinds and yet we are solidly in the black. We are extremely profitable, not what it was before but you have to consider the headwind. At the same time, we’ve clearly continued to invest in the business as far as profit, technology and cost point of view. We clearly stated with these cost savings that there will be a permanent benefit to a certain percentage of it. So ultimately when the mark occurred, we will have achieved our goal which was to come out of the downturn stronger than we went into it both from a market-share point of view and from a capability point of view. I think the records pretty clear that we are achieving that.
Now, what I can’t tell you, I can’t call the exact moment that the market will turn, and I think I have a different definition than what you described Todd. To me when the business stops going down, not necessarily that it’s going back up, but just stops going down, it’s a much better operating environment for us. Where the market is declining, like the types of declines we saw from May into the 3rd quarter, that is really difficult to manage because all kinds of issue come after you. For example, what your doing with your inventory to the standing levels in the store and you really are operating the business with tremendous intensity everyday. As soon as the business stops going down, your in a very different operating mode and your positioning yourself for recovery and how long we will be in that period where we stop going down and what I can predict. But if it stops going down that’s already quite something.
Todd Sullivan: Have you seen the rate of decline dropping substantially?
Mike Jackson: Let me put it in industry terms, there are a lot of people that are talking about the SAR in August is better than the SAR in July. That’s not enough for me. One month to me doesn’t mean much. I think it takes a couple months to really say supply stocks are going down.
Todd Sullivan: Are you seeing a situation where you have willing buyers walk through the door, but now because of credit conditions can’t get financing for cars?
Mike Jackson: Here is how I would describe it. First we have willing buyers walking through the door with no credit issues who say I’m going to wait, I think I can get it better price down the road. They think some bigger incentive is coming down the road because things are so bad, so they are sitting on the sidelines. Next you have those willing buyers coming through the door who we simply cannot get finances. It’s a combination that their credit position has deteriorated and the credit standards have gone up and in certain segments such as subprime its really difficult to find lending sources. For a committed customer as well as for certain brands you now have to veer them to another store because we can’t offer them an interesting lease offer, so there is no question that credit crisis is impacting buying. By the way that’s not just for us, that’s for housing, that’s for commercial real estate, I talk to my friends all the time and they have projects that are 50,60,70 percent pre-leased, they can’t get the projects funded where you used to be able to get them funded with nothing down.
The pendulum of this swung to far in the other direction and even though we had the rate cuts from the Federal Reserve they are not working like normal because the restriction of credit, it’s not really the cost of money, you can’t get the money. So this combination of this protracted housing situation and credit crisis and the cherry on top it gasoline has brought about the current circumstances that we are in. So it really is the combination that is dragging out what is basically a domestic recession. People say well, GDP grew 3.3%. Well you take out export and its good to have the export and they do support employment and everything, but if you really look at the domestic economy its in a protracted recession and the reason it’s not recovering as fast as everyone would like is the exact issue you’ve touched on Todd, the availability of the credit independent of the price.
Todd Sullivan: Alright, so if we go with that, then you’ve seen a dramatic drop off in demand because of other conditions, now you have willing buyers who are on the sidelines because they think they are going to get a better price and then you have people who want to buy but can’t because of credit. When all that shakes out like it always does, it just depends on when, then on the upside, one would expect a surge of demand, correct?
Mike Jackson: Yes, I would describe it like this. I felt in ’05 and ’06 the incentives were holding sales above trend and that we were pulling business forward and now we are in a period where sales are clearly below trend. I agree with you, when the recovery comes, depending which problem gets solved to which degree there is a substantial postponed purchases and those customers will come back into the marketplace.
Todd Sullivan: So #1 issue, what would you say it is, a lot is said about gas prices……
Mike Jackson: This is how it breaks down. Housing is 75% of the volume issue. Housing has created the credit crisis, when the housing crisis stabilizes and the banks know what all their mortgages are worth, that is going to lead to a stabilization of credit. That needs to come next. Gasoline is, if you look at it as a percentage of household income combined with all these other issues, is the last straw. But it gets a tremendous amount discussion and emotion and certainly when $4.00 gasoline is combined with the first two and in May, you had a breaking point, a structural shift in the mind set of consumers.
Now I would maintain that would if we did not have a housing crisis or if it didn’t have a credit crisis and we just got $4.00 of gasoline, what happened in May would have not happened. We would have had a lot of conversation and a lot of screaming and shouting, which we would have had the stampede to efficiency that occurred. So now the question is, as all that unwinds, how does it play back and the one that we are watching is housing. It’s nice to get the relief on the gasoline prices. I welcomed it considering everything the American consumer is dealing with but at the moment, the key issues would be housing.
Todd Sullivan: You said earlier you’re heading towards the luxury brand, BMW (BMW)/ Mercedes and then Honda (HMC)/Toyota (TM) you like also, is that because BMW/Mercedes brands are most profitable or they are most resistant to the situations we are seeing now?
Mike Jackson: All the above. First, the cars are extremely complex and require extraordinary technical skill to maintain and repair. They have owners who very much care about their vehicle and always want it in top performing condition. So the service and parts business is phenomenal. We brought over 100% fixed coverage in our premium luxury business, which is really marvelous place to be. Second, BMW/Mercedes are a juggernaut on the product innovation side. They really always have something new and exciting coming, so there is always something interesting to talk about. Finally when the market does get difficult, the last segment to go is premium luxury and you put it all that together and it’s a very attractive business.
Todd Sullivan: Do you see yourself going below the 20% of revenue in domestic brands? If people don’t buy them, then you may go below it out of your control, but do you see an intentional shift as you look at the landscape saying you know what, there is not much on the horizon coming out of Detroit for next couple years, should we shift more towards the other brand?
Mike Jackson: The way I think about is this way. I said some years ago that we were headed towards 30% and everybody asked me so what happens when you get to 30% and I said “ask me when we get there”. So now we are headed to 20% and we will probably get there in the next two, three years, and I would say okay call me back and ask me and I will give you the answer. There is a scenario where the domestic situation stabilizes depending on how much of a shake that there is and then it becomes an interesting enough business and we really like the 20% we have. Or, the position could deteriorate further and stores today that we are very happy with could become marginal and then we have to re-look at it.
So it could go either way. What I don’t see though, is that in two or three you would ask me that question I would say to you, you know what Todd, I think we are going to be in 25% or 30% in the next 2-3 years after that. So that I can rule out. I think there is a very good chance we will like the 20% we have, its profitable, or there is a chance of saying well the things developed we have to take another look at it.
Todd Sullivan: How hard or difficult is it when you say you have an existing Chevy or Ford (F) dealership, the physical building with salespeople and management is it possible to say, you know what I’m going to make a Toyota dealership, is there something that’s done?
Mike Jackson: Reallocating real estate is one of the things going on within this move and we are reallocating big domestic sites, moving imports along, and putting the domestics in a smaller site. We are reallocating capital and we are reallocation real estate that we already own towards imports and away from domestics. Within that whole journey is the 20%, which is a very efficient thing to do rather than having to meet the capital demand of the import to for more space in larger facilities and have to do projects from scratch. We already own the real estate and control the real estate in the market, and we simply reallocate it. That’s one of the major reasons why we like owning the real estate. It gives us the flexibility within our footprint to shift things around. Whereas you signed up on these leases, you have to go back to the landlords and negotiate change of use and change of franchise.
You can imagine the landlord, your going to and say, hey listen I have a great deal for you, I’m taking Toyota off this site and I’m putting a GMC dealership and I need your approval to do this. That’s not a fun conversation. Whereas if you own the real estate, like Bernie and I say, that’s what we should do.
Todd Sullivan: What time frame does that happen? If you made the decision today that GMC Buick (GM) dealership in Florida your going to change it to Toyota (TM) , it could take a year, six months?
Mike Jackson: It could take six months to a year. It still needs manufacturer approval, there’s always tweaking involved with the site, signage and all that stuff, but we’ve been doing this for several years too.
Disclosure (“none” means no position):Long AN, none
Visit the ValuePlays Bookstore for Great Investing Books