Industry factors

In June, South Africa’s new passenger vehicle sales fell by 26% year-on-year; following a 28% year-on-year decline in May. In the first six months of calendar 2008, passenger car sales were down a resounding 19% – a weakening trend that is cause for considerable concern.

The industry projection is that sales for the full year may be down by more than 20% – the worst drop in sales since 1998 when the prime interest rate was at 25,5%.

Only 18 months ago, the industry consensus was that GDP growth would tail off somewhat, but growth of the new middle class would be reflected in robust consumer spending and the new vehicle market would continue to grow until 2011. Most major manufacturers and car retailers held an optimistic market view.

Unfortunately, the sales decline was more abrupt and much steeper than expected. Stock levels went up significantly, and margin erosion was severe. In some cases, sales targets at which margin incentives begin to apply became unattainable. Manufacturers maintained the pressure to fulfil image, infrastructure and branding requirements as they felt another three years of growth was probable after a temporary pause in the upward trend. As a result, dealerships across the industry had to increase their fixed costs at a time when throughput was falling dramatically.

Heavy vehicle sales initially proved resilient, but gradually business confidence fell in sympathy with depressed consumer sentiment. McCarthy had limited ability to optimise early resilience at this end of the market as our sales ratio is 70/30 in favour of passenger vehicles.

Our relative strength in the affordable, fuel-efficient segment of the car market leaves us well positioned to benefit from a fundamental mood-swing in some sections of the car market following unprecedented fuel price increases. However, in current conditions, many buyers are staying out of the market altogether, whether for compacts or larger saloons.

The value proposition of quality used vehicles continued to improve. At McCarthy the average new car sold for R152 000 in 2003. By 2007, the average selling price was up more than 20% to R184 000. Over the same period, the used vehicle average price eased up from R98 000 to R102 000, only 4% higher.

Operational factors

The operational challenge was to optimise the benefits of our diversification strategy while compensating for plummeting new vehicle volumes through higher used-vehicle sales and stronger contributions from the parts and service component of our business.

Strategic diversion has picked up pace in recent years (motor retailing accounted for only 47% of profit in 2007 at a time of buoyant sales). The diversification dynamic was maintained with the integration of Viamax into McCarthy Fleet Services. Improved efficiencies and synergies resulted in strong profits, substantially ahead of management expectations for the initial integration period.

Our stronger used-vehicle offering also led to an encouraging increase in profit contribution.

Burchmores wholesale-to-the-public proposition proved a major success. Auction business – previously their sole focus – was brisk in view of the flood of repossessions, but the most notable aspect of Burchmores performance was the significant increase in retail sales to bargain-seekers.

The network still has only four retail floors nationwide, but by year-end had emerged as the country’s largest seller of used vehicles. Volumes rose from 3 600 units to 8 690.

Expansion of the network of McCarthy Value Centres also drove up used-vehicle volumes. The centres clocked up 2 324 sales while trading across the network under the banner of McCarthy Call-a-Car Direct resulted in a further 3 753 sales.

Access to repossessed vehicles and units coming through the Budget Rent a Car channel ensured that strong volumes were maintained without compromising our quality profile.

At 42 182, used vehicle volumes across Bid Auto were at a record high, up by 10% on the previous year.

Fleet sales – a traditional McCarthy strength – remained resilient. Our corporate marketing division did a good job of protecting key accounts among South Africa’s top 100 companies. However, margin erosion was significant.

Innovations/investments

Our used-vehicle business model was changed in good time to optimise market conditions. Previously, we wholesaled the majority of old model/high mileage trade-ins to the motor trade. Our dealers now offer all older stock to Burchmores. In 2008, Burchmores sourced more than 5 000 units from McCarthy dealers.

The McCarthy offering – quality used vehicles, seven-day exchange plan and warranty support – has been extremely well received by consumers eager to make the most of a no-risk purchase through the McCarthy brand backed by extensive aftersales infrastructure.

Newly launched McCarthy Value Centres were impacted by the late start-up of their Chinese imports, but developed some momentum thanks to the contribution by their Call-a-Car Direct franchises.

Initial results following the launch of the Meiya pick-ups and Foton mini-bus taxi (sourced from China by the Import and Distribution business) were disappointing. In May, we launched the new Chery after concluding an import and distribution agreement with Chery Automobile Company. The vehicle responds to market demands for affordable motoring. Initial consumer reaction was positive. The first four standalone Chery dealerships have been established.

McCarthy Heavy Equipment also opened a branch in Cape Town, an important addition to its infrastructure in a local market where construction activity is picking up.

Following the introduction of door-to-door and chauffeur options, Budget Rent a Car rapidly established itself as a leading provider of point-to-point services.

Our new Mercedes-Benz Lifestyle Centre in Menlyn, Pretoria, was nearing completion at year-end. It represents an investment by the Group of R110 million.

Risks

Trading results confirmed that sensitivity to business and consumer sentiment remains the single biggest risk faced by motor retailing. Risk is mitigated by diversification into related activities. Parts and service business can compensate to some degree for lower vehicle sales. In 2008, our parts sales grew by 15% while service turnover rose 19%.

Currency risk – even a slight weakening of the rand – tends to be exacerbated when consumer confidence is fragile and resistance to price increases becomes stronger.

Structural imbalance is also apparent within the motor industry as powerful international manufacturers face relatively small, localised dealers. The balance of negotiating power rests with the big motor brands. The disparity has widened in recent years as brand support requirements have been stepped up. The reality is that franchise dealers have limited commercial independence.

The cyclical nature of the industry also creates strategic risks.

When sales fall and profits stall, most businesses have the option of retrenchment, branch closures and sub-letting of premises. In the motor industry, skills are in short supply and growth depends on the availability of experienced, trained and well-motivated staff. Retrenchment can therefore be self-destructive. Furthermore, the loss of prime sites creates growth constraints once the industry cycle turns. In addition, there is little opportunity to sub-let premises as most facilities are customised to highly specific requirements.

Diversification helps mitigate the effects of a cyclical downturn as not all segments of the industry react in the same way at the same time.

A mismatch between retail and manufacturer reaction times has also been highlighted by recent events. Retailers are close to their market and quick to detect shifts in consumer mood. Major manufacturers apply long-term strategies and may mistake a fundamental shift in the market for temporary under-performance by a particular set of dealers. This can result in inappropriate investment and unrealistic targets at dealership level. When fixed costs are high, a mis-reading of the market soon affects the bottom line.

Crime affects all South African business, but motor retailing faces special risks in view of vulnerability to test-drive hijackings and the increasing use of fake documentation. Budget Rent a Car in particular has been affected adversely by the activities of highly specialised crime syndicates.

The risk of customer loss in an increasingly competitive and highly traded environment is constant for all industry players. Bid Auto addresses the issue through intense focus on customer retention and customer satisfaction. Scores in our 2008 used vehicle customer satisfaction survey were the highest ever at 89% (up from 86%).