Sonic Automotive, a major player in the American automotive retail scene, recently held a Q1 2024 earnings call brimming with optimism for their used car division, EchoPark. Their main takeaway? The tumultuous period for the used car market has subsided, wholesale prices are in freefall, and EchoPark is ready for a remarkable rebound. While it's an appealing story, a worrying fact seems to have escaped the attention of other analysts: Sonic's confidence may stem from a temporary edge, one that could evaporate as quickly as it appeared.

Let's revisit the recent past. The used car market was undeniably a choppy sea in late 2022 and early 2023. Supply chain bottlenecks, combined with the ongoing repercussions of the pandemic, led to a situation of scarce inventory and exorbitant prices. Many used car businesses, ill-equipped to handle the unpredictable conditions, went under. Sonic, with its broad business structure and significant resources, rode out the storm. They cleverly reduced EchoPark's reach, concentrating operations into 18 stores. This, they claim, allowed them to secure enough inventory for their remaining outlets, propelling both sales volume and profitability.

Here's the snag: Sonic's present success isn't entirely attributable to their operational expertise. A considerable contributing element is the less crowded market. The failure of several national rivals has created a gap in the used car market. Less competition translates to less strain on inventory procurement and, logically, improved margins for the survivors. This is where Sonic's narrative hits a snag.

Sonic frequently highlights the plentiful used car inventory at their disposal, stating they can "easily handle the amount of inventory" required for their 18 stores. They cite lease returns, rental car firms, and even loan defaults as sources of ample stock. But their unwavering conviction that "the bad days are behind us" feels premature.

What will happen when the used car market further stabilizes and attracts new participants? What will happen when those who pulled back come back, determined to reclaim their market share? The current void won't endure indefinitely. As competition escalates, Sonic's "easy" access to inventory could disappear, and their margins could rapidly shrink.

Let's delve into the figures. While Sonic predicts steady used car volumes for EchoPark in 2024, they foresee "low single-digit growth" for used car volume in their franchised dealerships. This disparity is significant. The franchise stores, operating in a highly competitive environment, are anticipating a more challenging fight. EchoPark, shielded by the current absence of nationwide competitors, enjoys an artificial advantage.

Consider this: Sonic's franchised dealerships are reporting a "400 to 500 basis point increase" in expenses compared to the "150 to 200 basis point increase" stated by some competitors. This suggests that Sonic, at least within its franchise activities, is already feeling the squeeze from competition.

Here's a theory: Sonic's optimistic forecasts for EchoPark rest on the premise that the current emptiness in the used car market will persist. If this assumption proves incorrect, their anticipated prosperity could quickly unravel.

The automotive retail environment is volatile and in a constant state of flux. A short-lived advantage can swiftly turn into a burden if a company misreads the forces at work. While Sonic deserves recognition for withstanding the recent turmoil in the used car market, their excessive confidence in EchoPark's future triumph, seemingly disregarding the potential effects of heightened competition, necessitates a cautious stance. The used car market isn't out of the woods yet, and the storm may not be as distant as Sonic believes.

Projected New Vehicle GPU Decline at Sonic

Source: Sonic Automotive Q1 2024 Earnings Call Transcript

"Interesting Insights:"

Shifted Consumer Preference: There's a growing consumer preference for hybrid vehicles over fully electric vehicles. Source: Sonic Automotive Q1 2024 Earnings Call Transcript

Technician Shortage: Sonic is actively trying to address a shortage of technicians, aiming to hire 300 more in 2024. Source: Sonic Automotive Q1 2024 Earnings Call Transcript

EchoPark Performance: EchoPark is experiencing high demand, with some stores selling over 30 cars per salesperson. Source: Sonic Automotive Q1 2024 Earnings Call Transcript