William J. O’Flaherty, Director, Matt C. Oldhouser, CPA, Senior Analyst and Duncan C. Rogers, Analyst

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Introduction
The automotive aftermarket encompasses a diverse set of business functions that support the ongoing car care needs of various vehicles (personal, commercial, etc.) following the initial purchase. The sheer magnitude of this marketplace in comparison to the original equipment manufacturer (“OEM”)/dealer supply chain is extraordinary, although the two sectors have been increasingly overlapping given the attractive business fundamentals exhibited by the aftermarket.

Over the years, operators in the automotive aftermarket have experienced sustained success based on several foundational industry characteristics. First, by the very nature of the marketplace, earnings generated by businesses are largely recurring. While the initial vehicle purchase is a one-time event, the ongoing maintenance, parts and miscellaneous services required to keep it running are all ongoing expenditures. While not a one-to-one correlate with the famed “razor-razorblade” business model, the predictably recurring nature of revenues in the marketplace creates customer/brand loyalties and exceptional profitability for astute operators.

Second, the aftermarket benefits from a growing base of vehicles on the road today. As automotive technologies continue to evolve, the ability for cars to remain on the road longer (a credit to the innovation of the manufacturers) has become a theme in this sector. When faced with the opportunity to trade-in/trade-up or simply repair, more and more consumers are choosing to maintain their existing vehicles by turning to an increasingly reliable and convenient set of aftermarket service providers. This trend has created an average vehicle age that reached 11.8 years in 2019 (up from 8.8 years in 1999), with exceptionally-aged vehicles (those 16 years and older, and by their very nature, requiring more repairs) expected to grow at a rate of 22.0% from 2018 to 2023. These dynamics, in addition to the growing complexity of “what’s under the hood” of new vehicles, have created an exceptional base of prospective customers for operators in the automotive aftermarket.

Lastly, and largely a function of the items identified above, the automotive aftermarket enjoys recession resistant and arguably countercyclical demand. While all businesses confront unique challenges during recessionary periods, the automotive aftermarket benefits as consumers more closely manage expenses during economic downturns. Even outside of recessionary periods, consumers have had a difficult time keeping pace with accelerating new vehicle prices. Over the past two decades, the average cost of a new car has increased nearly 30%, while median household income only rose approximately 6% during that same time. This is largely attributable to enhanced features/technology, including government mandated fuel economy standards, that, while additive to the vehicle package, don’t correspond to value for consumers experiencing financial duress. Therefore, particularly in times of hardship, prospective new car buyers continue to repair existing vehicles for a fraction of the cost of buying new. It is this recession resilience, which is notably unique to retail and most service markets, where we find owner-operators increasingly focused given the macroeconomic backdrop that exists today.

As the macroeconomic environment surrounding COVID-19 continues to evolve, we are increasingly hearing from private business owners asking what opportunities exist for small-to-medium-sized businesses in the automotive aftermarket during turbulent market conditions. Is now the time to invest in growth or “protect the fort”? If an owner had plans to sell in the next 12 to 18 months, how does this impact the value of their business? In an effort to respond to these questions, we have taken a closer look at the past two U.S. economic recessions to determine what, if any, takeaways are relevant for business owners and marketplace stakeholders today. Though each economic downturn possesses its own distinct challenges, most notably the magnitude and severity of the downturns themselves, several useful patterns emerged that could create exceptional value for dynamic automotive aftermarket operators.

The 2001 Recession
Summary of the Events and Response
The 2001 recession, the tenth in the U.S. following World War II, lasted just nine months, from March to November 2001. Notwithstanding the short duration, this period of unrest led to stagnant growth for many globally developed economies as terrorism fears were widespread. Leading up to that timeframe, from 1994 to the mid-2000’s, U.S. economic performance was exceptional, averaging 4% annual growth in real GDP. In an effort to dampen inflationary fears, the Federal Reserve raised the federal funds rate from 4.75% in June 1999 to 6.50% in May 2000. The result was as anticipated, and an otherwise healthy U.S. economy began to slow.

In many ways, the growth leading up to the recession in 2001 could be attributed to the evolution of several “dot-com” businesses. With the accelerated use of the internet, more and more start-up enterprises focused on opportunities to take advantage of this new marketplace. Several of these companies, including AOL.com, Pets.com, and Webvan.com, achieved exceptional valuations as investors focused on lofty growth aspirations, as opposed to current profitability. As the broader economy cooled as a result of the Fed’s monetary actions, investors’ exuberance for the internet startups followed suit. Eventually, a tech-focused Nasdaq Index lost approximately 75% of its value, signaling the burst of the dot-com bubble.

The attacks of September 11, 2001 were tragic and had a significant emotional and economic impact on the nation. Fear and uncertainty were widespread, and those factors took a toll on several global markets. The New York Stock Exchange was closed for several days following the attacks, with its reopening seeing a severe decline in the Dow Jones Industrial Index. While the terrorist attacks certainly had a negative effect on the markets, it’s important to recognize that it was primarily a compounding impact of a recession already in motion.

Response to the market downturn by the U.S. government and the Federal Reserve was swift, and according to several economists, highly effective. Between January 3 and December 11, 2001, the federal funds rate was reduced from 6.50% to 1.75%. This decision was made out of an effort to stimulate the economy by providing more liquidity for businesses and consumers.

There was also an easing of fiscal policy in 2001, with the passage of a tax cut in the form of the Economic Growth and Tax Relief Reconciliation Act of 2001 and a shift from a large budget surplus to a deficit. The tax rebate combined with the reduction in personal income tax rates raised the average disposable income of households and subsequently led to an increase in spending. Although industrial production slowed during this period, consumer spending remained strong as unemployment held at relatively low levels and personal income continued to increase. Lower interest rates also allowed consumers to invest significantly in both real estate and automobiles, thereby stimulating the economy.

Influences on the Automotive Aftermarket
New Vehicle Sales and Auto Parts Retail Revenue
Many industry analysts believe that consumers’ appetites to purchase new vehicles are driven by disposable income and consumer confidence. In other words, as buyers become more confident in the economic prospects of the nation and as their financial wherewithal builds, they become more apt to purchase new cars. In addition to the personal financial situation of the individual consumer, the new car decision-making process can also be influenced by several external factors; chief among these are dealer incentives, including cash rebates and advantageous financing terms.

The rate of consumer spending during the 2001 period was incredibly unique relative to other periods of economic decline. Every downturn in the 30 years preceding 2001 was met with a corresponding decline in consumer spending. Why the change in 2001? First, the monetary and fiscal policies implemented at the time had a dramatic effect. Americans simply had more disposable income as a result of the measures taken by the government to address the recession. Additionally, carmakers, starved for sales and willing to sacrifice marginal profitability, began offering exceptional incentives. Zero-percent financing options were first initiated by General Motors shortly after the September 11 attacks, with Ford following shortly thereafter. The program, which cost manufacturers between $1,500 and $3,000 per vehicle, was touted as “the most generous [offer] in automotive history”. Their decision to sacrifice near-term (and possibly long-term) profitability was effective and drove record-breaking sales from September through November 2001.

Prior to these incentives being offered, new vehicle sales had stalled significantly as a result of the recession. This has, unsurprisingly, been the case for nearly every significant recessionary period. While vehicles are a necessity for many, upgrading or buying a new vehicle is viewed as a luxury purchase that can be deferred during periods of economic hardship. Instead, consumers turn to maintaining and repairing their existing vehicles. Later, as economic concerns begin to subside and sustained growth becomes realistic, typically a “pent up” burst of dealer sales occurs.

Notwithstanding the impact of dealer incentives, the automotive aftermarket remained steady and grew during most of the recession. While the depth of the recession was fairly shallow, and despite the effects of dealer incentives, the long-term theme of consumers repairing versus replacing vehicles during downturns held true.

Employment and Number of Active Businesses
While unemployment rose as a result of the 2001 recession, it was not as meaningfully impacted as prior recessions. As a result of the preceding years of growth, and before economic uncertainty hit, the unemployment rate was 3.9% in September 2000, an exceptional measure. At its peak during the recession, total market unemployment rose to 5.5%.

When focusing on the automotive aftermarket, unemployment remained relatively consistent throughout the recession as a result of the strong consumer spending identified above. However, as the economy turned again to growth mode, dynamic operators took advantage of the chance to accelerate hiring once again.

Further impacting employment figures, the number of automotive aftermarket businesses in operation declined in 2001. While the number of enterprises that closed their doors was relatively modest compared to larger recessions, they tended to be businesses on a smaller scale, with lower unit counts, and with limited access to financial resources. The years following 2001 saw a significant increase in new operators, which resulted in a tightening of the market for qualified salespeople and technicians in the auto aftermarket.

Business Valuation
A recurring market theme, and one that becomes more pronounced in economic downturns, is the divergence of valuation multiples for the automotive aftermarket versus the broader S&P 500 Index. Valuation multiples measure the value of a business relative to a core financial metric of that business (e.g. revenue, assets, profitability, etc.). The higher the valuation multiple, the more “valuable” that business is relative to the underlying financial metric.

In periods of economic uncertainty, and more specifically recessions, we note that large, publicly traded automotive aftermarket businesses experienced an increase in their valuation multiples, while the multiples of the broader market (illustrated by the S&P 500 Index) either decrease or stay flat. Said another way, a dollar of earnings from a business in the aftermarket becomes more valuable to prospective investors while the broader market tends to see the opposite effect.

This is incredibly valuable information for operators of private businesses as well. If we assume that, as a whole, these publicly traded automotive aftermarket businesses represent a sub-segment of top-tier operators in their market, then the appreciation of relative value should also extend to exceptional privately-held enterprises as well. We believe this phenomenon is indicative of investor interest in the automotive aftermarket, and more directly, the recognition of the growth opportunities that exist in the market both during and after a recession. It should also be noted that this is not a universal principal across the industry, as some automotive aftermarket participants do fail as a result of poor business fundamentals; however, successful operators can expect significant investor interest both during and in the wake of recessions.

From the start of the 2001 recession to its conclusion, a business in the automotive aftermarket with the exact same EBITDA [1] was worth 8.4% more than the beginning of the recession. Inversely, the average business in the S&P 500 with the same cash flow profile yielded a value 0.8% less than at the beginning of the recession. While remarkable, this dynamic appears to grow based on the severity of the recession, as illustrated in the 2008 Great Recession.

[1] EBITDA stands for Earnings Before Interest, Taxes, Depreciation, and Amortization and is a metric used to evaluate a company’s operating performance

The 2008 Great Recession
Summary of the Events and Response
The longest and most severe economic downturn since the Great Depression, signs of the Great Recession came long before the 2007 – 2008 global economic meltdown. Most economists trace its origins to the subprime mortgage market, which peaked in 2006. These loans, which were packaged by large financial institutions into mortgage backed securities (“MBS”), were offered to subprime, high-risk borrowers. As home prices declined in 2007 and interest rates on these subprime loans were reset, the default rate increased exponentially. Still, the financial institutions that held these loans on their balance sheets had purchased insurance products against the risk of mass defaults. These insurance products, known as credit default swaps (“CDS”), were issued in exceptional quantities by large insurance companies like American International Group (“AIG”) to support the ever-growing MBS marketplace. When the domestic housing market ceased its meteoric ascent and homeowners began walking away from their mortgages, the MBS market collapsed, and insurance entities lacked sufficient capital to support the insurance products they had issued. Without the safety net of the credit default swaps, the value of the derivatives held by financial institutions plummeted. Many banks, hedge funds, and insurance firms were left holding worthless investments.

What came next was an exceptional, global, liquidity constraint. Banks were leery of lending to one another for fear that the borrower held high balances of illiquid and devalued derivatives. With these lending markets drying up, strained financial institutions became overwhelmed. While the first significant bankruptcies started with smaller institutions such as mortgage originators New Century Financial and American Home Mortgage, larger financial institutions came into play as the crisis worsened.

Bear Stearns, Merrill Lynch, Fannie Mae, Freddie Mac, AIG, and Lehman Brothers all found themselves in peril as a result of their exposure to subprime mortgages. While several of these institutions were given a lifeline by the federal government, Lehman Brothers was allowed to declare bankruptcy, the largest ever such filing. The failure of this banking mainstay sent shockwaves through the global financial markets and panic set in. Two weeks after the Lehman Brothers bankruptcy, the stock market crashed, with the Dow Jones Industrial Average seeing its largest ever point drop at that time. Additionally, there was a run on money market funds, which are essential cash flow for many businesses. Eventually, numerous large, historic institutions, including General Motors, Chrysler, Bank of America, and Citigroup, would require assistance or risk a fate similar to Lehman Brothers.

In response to the unprecedented economic crisis, the Federal Reserve and U.S. government (as well as similar institutions globally) approved an avalanche of fiscal stimulus and softening monetary policies. Given the duration of the recession, these actions were taken in waves, but amounted to a diverse and highly complex mix of bailouts, guarantees, and other liquidity measures.

While the U.S. government and the Federal Reserve originally attempted to barter deals between distressed institutions and their healthier counterparts, such as the acquisition of Bear Stearns by J.P. Morgan, the distressed assets themselves became perceived as so toxic, that the government had to step in directly to assist. With Fannie Mae and Freddie Mac teetering on the edge of ruin, the Bush administration intervened and took control of both institutions. Similarly, the Federal Reserve agreed to lend AIG approximately $85 billion so that it could remain afloat.

In October 2008, Congress established the Troubled Asset Relief Program (“TARP”), which armed the government with $700 billion in funds to purchase the assets of struggling companies in order to keep them in business. Almost immediately, over $100 billion of those funds were provided to banks to help secure their balance sheets and promote healthy credit markets. As the calendar turned to 2009, TARP, as well as other economic support programs, were made available to General Motors, GMAC, Chrysler, and Ford Credit.

The U.S. fiscal policy response was generally in line with levers utilized during previous administrations. In early 2008, President Bush and Congress passed the Economic Stimulus Act, which primarily provided $600 – $1,200 rebates to families and reduced taxes. The $152 million stimulus was designed to stave off the pending recession. Similarly, in 2009, newly elected President Obama and Congress combined many stimulus measures into the American Recovery and Reinvestment Act. The law provided $787 billion (later revised to $831 billion) in tax cuts as well as spending on infrastructure, schools, and healthcare. By June 2009, these combined measures helped the U.S. economy exit the longest recessionary period since The Great Depression.

Influences on the Automotive Aftermarket
New Vehicle Sales and Auto Parts Retail Revenue
Unlike the recessionary environment that existed in 2001 in which consumer spending was not significantly impacted, the 2008 period of economic downturn had parallel declines in both consumer spending and private business investments. As a result, new vehicle sales, which are negatively correlated with automotive aftermarket business performance, decreased consistently throughout this 18-month period. The full effects of this decline in consumer demand for automobiles is evidenced by the unprecedented financial bailout provided by the federal government to domestic automakers, many of whom faced impending bankruptcy. Federal aid, along with a focus on strategic initiatives targeting consumer spending, allowed OEMs to be well-positioned for the end of the recessionary period when consumer sentiment trended positive and customers began making large purchases again.

As seen in the graph above, automotive aftermarket revenues, specifically auto parts retail, were generally resilient throughout the recessionary period, even increasing during some of the most severe months. This is in-line with performance of the industry seen in previous recessions and supports analysts’ understanding of the relationship of the industry with consumer behavior. However, the shift in consumer sentiment and purchasing trends at the tail-end of the recession caused a significant uptick in new vehicle sales, and similar to trends seen in recent history, auto parts retail revenue declined sharply.

The most significant declines were in performance parts and accessories, as well as similar categories classified as discretionary purchases. These types of purchases can typically be delayed, unlike those in the break-fix-repair categories.

The trough seen for auto parts retail revenues in the fourth quarter of 2009 was fleeting in nature and the industry was able to rebound rapidly: only five months later monthly revenues exceeded any period during the recession.

Employment and Number of Active Businesses
Total unemployment rose to 9.5% during the 2008 recession, while a similar trend was seen within the automotive aftermarket. The total number of employees in the sector decreased over the course of the recessionary period, largely due to cost-cutting and consolidation strategies utilized by smaller companies without the necessary resources to continue normal operations. In many scenarios, these companies were unable to stay afloat throughout the economic downturn and were forced to file for bankruptcy or sell at heavy discounts.

One of the key takeaways business operators should glean from these employment trends is the critical nature of this period for headcount considerations. As consumer sentiment and GDP turn positive and signal the end of a recession, many operators intensely target talented employees that were cast-off by less successful or more conservative businesses. As employment trends pick-up post-recession, this window is important to gather and retain talent to help position companies for growth as the economy rebounds.

Business Valuation
Performance of the automotive aftermarket index in 2008 largely mirrored the effects seen in 2001. As the recession progressed and stretched over an 18-month period, automotive aftermarket companies benefitted largely due to consumers’ reliance on older vehicles that require routine maintenance. Again, it should be noted that this appreciation in valuation was attributed to exceptionally run companies that were able to absorb the impacts of an economic downturn. Companies without similar resources were forced to consolidate their efforts through layoffs and store closures, and in many scenarios, even file for bankruptcy. The environment that is created through the divergent paths of businesses in the industry is one that is well-suited for consolidation through strategic acquisitions.

By the close of the recession, a business in the automotive aftermarket with the exact same EBITDA was worth 50.3% more than at the beginning of the recession. Inversely, the average business in the S&P with the same cash flow profile yielded a value 31.5% less than at the beginning of the recession.

Although the automotive aftermarket index illustrated above only accounts for large, publicly traded companies, privately-owned business owners can expect a similar boost in valuation if operations are best-in-class. The recession-resistant nature of the industry is attractive to potential investors, and the tail-end of an economically depressed period represents an opportunity to take advantage of these factors.

2020 COVID Market Impact
Summary of the Events and Response
A decade of domestic growth, spurred in part by low borrowing costs and a broadly business-friendly environment, was quickly interrupted with the arrival of COVID-19 to the United States in January 2020. While the first reported U.S. case occurred in mid-January, and the Trump administration declared a public health emergency in late-January, the country as a whole largely downplayed the impact of the virus until mid-March, when a national emergency was declared.

In the following weeks, domestic and international travel came to a complete halt, all non-essential businesses were closed, and societies across the globe implemented social distancing measures to stem the pace of the virus’s growth. These measures had devastating and widespread impacts to the global economy. Uncertainty and fear ravaged the public markets during weeks of volatility. As businesses were forced to shut down as a result of social distancing, unemployment began to skyrocket. With so many out of work and uncertain about when they would return, fear and unrest spread across the entire economy.

Again, recognizing the severity of the situation both domestically and globally, the U.S. government and the Federal Reserve began to take swift action. Congressional response came in waves. On March 6, the Coronavirus Preparedness and Response Supplemental Appropriations Act provided $8.3 billion to help fight the pandemic, including research and monetary support for various health and local agencies. That bill was followed shortly on March 18 by the Families First Coronavirus Response Act, which identified areas of priority, such as paid emergency leave, food assistance and free virus testing.

Most notable among the government’s responses to date is certainly the Coronavirus Aid, Relief, and Economic Security (“CARES”) Act, a $2.0 trillion measure that included funds for small business loans, loans to large businesses (including airlines), local governments, hospitals and unemployment insurance, as well as payments to individuals. The goal with all of these measures was not only to safeguard the general population, but to also provide some form of financial relief to individuals and businesses impacted by the pandemic.

The Federal Reserve also stepped in with a dizzying amount of instruments to minimize the financial impact of the pandemic, including trillions of dollars to support households, employers, financial markets, and state and local governments. In addition to lowering interest rates to near-zero, the Federal Reserve tapped its playbook from the Great Recession with quantitative easing measures ($700 billion in treasuries and mortgage-backed securities), backstopping money market mutual funds, and encouraging bank lending by easing regulatory requirements. Perhaps most illustrative of the magnitude and severity of the crisis, the Federal Reserve also initiated direct lending programs to major corporate entities as well as state and municipal governments. It is now armed to purchase billions of dollars of corporate/municipal bonds, provide direct loans to large corporate businesses, and support loans to medium sized businesses through its Main Street Lending Program (a larger business equivalent to the Small Business Administration’s Paycheck Protection Program).

In equal measure, the overall response has been as extensive and unique as the economic and social damage caused by the COVID-19 pandemic. As a result of this comprehensive response, new COVID-19 cases and deaths appear to have plateaued and many state governments have begun easing restrictions. While the journey back to full recovery will likely be long, cautious optimism has started to return to the national conversation.

Influences on the Automotive Aftermarket
Overall Industry Impact
To date, despite the vehicle repair market’s widespread classification as an essential business, the coronavirus has had a fairly adverse impact on the automotive aftermarket as a whole. While the extent of the effect pales in comparison to those felt by the restaurant and brick-and-mortar retail industries, the pandemic will have lasting impacts on the automotive aftermarket that will certainly be sustained through the remainder of the calendar year, if not beyond.

Most concerning to economists is the general uncertainty that weighs on everything surrounding the pandemic. The guidance provided by experts continues to evolve as more data about the virus becomes available, resulting in forward-looking consumer demand remaining unpredictable at best. Given the probable severity of the economic impact and our assumptions about the length of a potential recession, we can infer that the impacts to the automotive aftermarket will likely resemble those of the Great Recession (December 2007 through June 2009), more so than the 2001 Recession.

New Vehicle Sales and Auto Parts Retail Revenue
Auto parts retail sales, an effective proxy for the health of the automotive aftermarket, fell sharply at the onset of the coronavirus. This was largely due to a confluence of: consumer apprehension based on social distancing guidelines; limited demand instigated by stay-at-home/remote work cultural shifts; and the inherent limited capacity afforded to businesses attempting to safely operate during the health crisis.

Despite these factors, our outlook for the automotive aftermarket remains optimistic. We believe there is a large pent up demand for vehicle repair work that will release into the marketplace, as society eases back into relative normalcy. Moreover, government financial support of individuals impacted by COVID-19 (primarily those initiated by the CARES Act) will provide sufficient funds to sustain deferred break-fix-repair services.

Additionally, we question the level of consumer interest in new vehicle sales as an alternative to repair in the immediate and medium-terms. While technology-supported remote vehicle purchasing remains an important and growing revenue stream for new car dealers, those remote/e-commerce sales will likely only marginally offset declines for in-person vehicle purchases. April 2020 retail sales of new vehicles fell approximately 41% year-over-year, a clear illustration of the headwinds facing dealers. Finally, to the extent social distancing guidelines continue to influence consumer behavior, we believe those will have a far greater impact on the dealer market than the aftermarket retail and repair sector.

Employment and Number of Active Businesses
Resulting from the COVID-19 and social distancing-led shutdown of over 100,000 small and medium-sized businesses, total U.S. unemployment statistics have deteriorated to levels not seen since the Great Depression. Despite the resiliency of the automotive aftermarket, the broad sweeping societal restrictions have understandably impacted the market more severely than in past downturns. Prior to the pandemic, competition for highly-trained technicians and salespeople in the automotive service sector was already fierce.

We believe both the number of employees and the number of industry participants will remain artificially inflated for a period of several months. As coronavirus-specific federal programs designed to assist displaced workers and struggling businesses come to a close, we anticipate a fairly swift fallout. Given the number of independent operators in the automotive aftermarket, including franchisees of large institutions, it should come as no surprise that many operators applied for and received Paycheck Protection Program assistance from the Small Business Administration. While these loans provide a valuable life line to struggling business owners and their employees, some operators will not have the independent financial wherewithal to withstand the economic turbulence. We anticipate these circumstances will lead to valuable, strategic acquisition opportunities, as well as a surge in voluntary and involuntary employee turnover.

Business Valuation
As with prior recessions, meaningful valuation inferences have been slow to appear as the economic downturn has unfolded. Given the expected magnitude and duration of the pending recession, we anticipate the value appreciation for the automotive aftermarket index to more closely resemble that of the 2008 Great Recession. This dynamic will likely drive a number of privately-held businesses to consider liquidity options and therefore create consolidation opportunities for larger industry players.

Expected Industry Impact
The nature of the COVID-led economic downturn is extremely unique relative to past U.S. recessionary periods. Social distancing has impacted both consumer and business behavior in ways prior periods did not, and these negative effects will be felt for months, and likely display residual fallout for years to come. Specific to the automotive aftermarket, vehicle miles traveled have decreased dramatically due to the temporary closure of non-essential businesses and widespread, state-issued stay-at-home orders. This has dampened the need for both routine maintenance work, as well as immediate repair work prompted by collisions. In totality, the consumer automotive aftermarket retail experience is likely to remain positive, as the deferred maintenance and ongoing needs of consumers will be met with a refreshed business infrastructure that will be organized around safe, but limited interpersonal interactions. Our expectation is that these combined factors will cause aftermarket retail sales and repair expenses to lag the traditional recovery curve demonstrated by prior recessions; however, in the long-term, we anticipate the prospects for the automotive aftermarket to be more robust.

As previously stated, signs point to the current economic disruption mirroring the impact of the Great Recession more so than the 2001 financial crisis. Therefore, we believe many economic contributing factors (most notably consumer confidence, unemployment, and real wages) will influence consumers to continue to hold on to and maintain used/older vehicles rather than trade-in or trade-up for newer models. Moreover, the heightened societal awareness of shared, enclosed spaces, will depress the enthusiasm for these consumers to effectively “trade-down” to public transportation options, at least for the short-term.

While prior economic downturns have seen a post-recessionary spike in new vehicle purchases, we anticipate that consumers will likely use excess funds (supported by the federal government) for deferred maintenance as opposed to making a new car purchase. Our belief is that the amount of the monetary assistance provided to working individuals and families ($1,200 – $2,400 in stimulus checks in addition to the $600 weekly unemployment boost) yields sufficient disposable income to support repairs, but not new vehicle investments.

In the near-term, we do expect the valuation gap between the automotive aftermarket and other sectors to widen as it did in prior downturns. This has been slow to manifest itself to-date; however, we note that in prior recessionary periods, the valuation divergence didn’t emerge until the later stages of the downturns. It is likely that the market is simply anticipating a prolonged uncertainty period prior to a full recovery and we look for a valuation uptick to emerge as optimism continues to enter society’s collective mindset.

Conclusion
What does all of this mean for private business owners in the auto aftermarket? First, it’s still an opportune time to consider a sale. The appetite for acquisitions or investments into the automotive aftermarket is minimally impacted by recessions, similar to the marketplace itself. There will consistently be buyers or investors that are willing to explore transactions with businesses in aftermarket sales and repair. Additionally, as previously addressed, a valuation imbalance tends to emerge in the automotive aftermarket that could be quite beneficial to business owners. In short, contemplating a sale near the end of an economic downturn could be fruitful and garner significant interest from potential buyers.

Alternatively, for owners who are focused on continuing to run their businesses, now would be an opportunistic time to examine distressed or under-performing acquisition candidates. As we know, recessionary periods create financial distress for some groups of operators, regardless of the industry. From 2007 – 2009, largely as a result of bankruptcies and general M&A activity, the number of operating businesses in the aftermarket industry declined by 7.1%. We believe it is likely that a similar wave of consolidations and bankruptcies will occur in the wake of COVID-19 as the traditional lending markets continue to experience disruption. The valuation lift afforded to top-tier operators does not generally apply to businesses in financial distress, and therefore, could present future arbitrage opportunities for knowledgeable consolidators.

The middle and later stages of a recession are also good times to consider reinforcing management and other employee ranks. While labor markets today are soft across many retail and service sectors, we believe employment demand in the aftermarket will recover quickly (as illustrated in prior periods). COVID-led unemployment won’t be the only driver of turnover, as the fear of changing retail/service experiences and poor employee management (returning to work conditions, etc.) will cause many operators to potentially lose good managers/mid-level employees. These workers will look for rational operators, economic upside, and stability for future long-term employment. Top-echelon business owners can plan for all of these needs and attract more than their share of qualified candidates. Active hiring in recessionary periods avoids heated competition for talent post-downturn, and also supports operational stability and growth.

In every market disruption, winners and losers emerge. There will unfortunately be some fallout for select operators, but history has proven that growth-oriented, exceptionally-managed aftermarket businesses have an opportunity to thrive as a result of recessions. Ownership preferences of these companies will dictate where they fall on the spectrum of divestment vs. status quo vs. growth, but the industry-specific tailwinds matched with proven oversight, should allow for a successful outcome regardless. Most importantly, operators should absorb the lessons learned from prior recessions to inform their decision making in addressing current market conditions and the potential growth period that will likely soon follow.

Disclaimer
The contents of this publication are presented for informational purposes only by Matrix Capital Markets Group, Inc. and MCMG Capital Advisors, Inc. (“Matrix”), and nothing contained herein is an offer to sell or a solicitation to purchase any of the securities discussed. While Matrix believes the information presented in this publication is accurate, this publication is provided “AS IS” and without warranty of any kind, either expressed or implied, including, but not limited to, the implied warranty of merchantability, fitness for a particular purpose, or non‐infringement. Matrix assumes no responsibility for errors or omissions in this presentation or other documents which may be contained in, referenced, or linked to this publication. Any recipient of this publication is expressly responsible to seek out its own professional advice with respect to the information contained herein.

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