by Lawrence Meyers | July 26, 2012 10:00 am
I am not a fan of the new car buying business — margins and sales growth come from selling used vehicles. That being said, both new and used cars have enjoyed double digit sales growth since the economy bottomed out in 2009 and companies like AutoNation (NYSE:AN) are enjoying the best of both worlds.
If you examine the chart below, courtesy of Sageworks, new car sales got destroyed in the financial crisis but also bounced back with greater power than used cars did.
And while used cars suffered, it wasn’t as much — but they still also enjoyed a robust sales rebound. Part of the reason for this surge is that while auto sales plummeted during the recession, population growth remained steady. That created pent-up demand, which is why we’re seeing these double-digit growth rates.
Plus, last month’s housing starts hit a four-year high, and there is strong correlation between housing starts and pickup truck sales. Trucks offer great margins compared to sedans, and Ford (NYSE:F), GM (NYSE:GM) and Chrysler reported a 13% increase in full-size pickups in the first half of this year.
On top of that, the average car in the U.S. is 11 years old. That’s old. And those cars will need to be replaced. Investors should expect that growth to return to the mean, but in the meantime, automobiles are enjoying a large part of the recovery.
Which brings us back to AutoNation.
The company offers new vehicles, used vehicles, parts, automotive repair and maintenance services and automotive finance and insurance products — which arranges financing for vehicle purchases through third-party finance sources. It also offers various vehicle protection products, including extended service contracts, maintenance programs, guaranteed auto protection, tire and wheel protection, and theft protection products.
This broad diversification gives it exposure to all parts of the industry and also provides a hedge during the downside. The financial products in particular, along with used cars and collision repair, provide super-high margins. The company is thus able to significantly leverage its balance sheet because it can finance vehicles at an ever higher rate and play the arbitrage.
AutoNation just reported a 17% increase in revenue on a 29% increase in vehicle sales, a gross profit increase of 8% and a 35% increase in adjusted EPS. The company is on track to increase EPS 28% this year, 13% next year, and 18% annualized over the next five years.
It also produces robust cash flow, has manageable debt and has a good hold on inventory. If we assign an 18x multiple to this year’s earnings of $2.48, we get a rough fair value of around $45. With the stock trading at around $39, it suggests a value.
Sonic Automotive (NYSE:SAH) is less than 20% of the market cap of AutoNation and is also worth a close look. It’s growing at about 17% on 2012 EPS of $1.64, giving it a fair value of $27, but is trading at only $17. However, it’s paying interest at mezzanine rates with weaker cash flow.
CarMax (NYSE:KMX) is the big kahuna in the used car arena but at $27 seems a bit pricey for its $21 fair value.
AutoNation makes a lot of sense if you want to have exposure to the economic recovery and auto sales. I don’t like the pure plays like Toyota (NYSE:TM) or Honda (NYSE:HMC) because, as we saw with Toyota, you could get surprised by some bad internal controls. AutoNation offers diversity across the entire automotive sector and I think it’s a buy.
Lawrence Meyers does not own shares in any company mentioned.
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