Car Dealers: 2 Stocks to Drive, 2 to Park

by Susan J. Aluise | November 8, 2012 6:15 am

Car Dealers: 2 Stocks to Drive, 2 to Park

“Frankenstorm” Sandy was a speed bump for October auto sales, but experts say those missed opportunities are not lost, just “deferred” — and that’s great news for car dealer chains counting on pent-up vehicle demand.

U.S. auto sales grew by 7% in October, as dealers sold new cars and light trucks at an annualized pace of 14.3 million vehicles[1] — significantly below the 14.9 million industry observers had expected. Sandy, which wreaked havoc on eastern seaboard at the end of the month, is blamed for 20,000 to 30,000 missed sales.

But industry experts believe those sales were just delayed, not denied. The auto research firm Edmunds.com believes that the industry not only will recapture those sales, but could even see “an extra bump” of as many as 100,000 vehicles[2] from consumers who now must replace storm-damaged autos.

While current trends will boost dealers’ fortunes, some stocks are a better bet now. Here are two car dealer stocks to drive — and two to park:

Drive

Lithia Motors (NYSE:LAD[3]): This small-cap ($890 million) operator in the West and Midwest celebrated stronger-than-expected third-quarter earnings on Oct. 24. Earnings per share surged 48%, and revenue rose 24% on same-store new-vehicle sales that improved 30% and used-vehicle sales that rose 24%.

I like Lithia because it’s expanding while managing to keep its selling, general and administrative expenses low.

LAD has gained roughly 60% year-to-date, and even set new highs above $36 per share in October before pulling back to its current price around $33.50. Its price/earnings-to-growth (PEG) ratio of 0.76 indicates it’s undervalued, and its forward P/E of 11 is inexpensive, too.

Penske Automotive Group (NYSE:PAG[4]): Penske — a name with plenty of cache in America’s racing scene — not only deals in new and used auto sales, but also servicing and repair.

PAG shares were pummeled last week after the company’s third-quarter earnings beat Wall Street estimates on sales and earnings. The stock shed about 10% Friday on investor concerns about declining margins … but I think that was a knee-jerk reaction, considering PAG posted an otherwise strong quarter.

I like that Penske’s revenue growth has been driven by strong retail sales: PAG sold more than 88,000 new and used vehicles in the quarter — an increase of nearly 24%. New vehicle sales, which account for half of the company’s sales, rose by 26%.

Unlike many of its competitors, Penske has franchises outside the U.S., most notably in the U.K. International sales grew at a quicker clip than did domestic sales during the quarter — 29% to 21% — perhaps indicating slightly better fortunes in Europe. PAG’s numbers also were helped out by German luxury brands like BMW.

Like Lithia, PAG has been vastly outperforming the market (up 45% year-to-date) and set new all-time highs in October before pulling back of late. The stock has one of the lowest PEGs in the sector (0.5) and a forward P/E of less than 12, plus it also yields a modest 1.8% in dividends.

Park:

AutoNation (NYSE:AN[5]). AN isn’t a bad auto dealer stock by any means — the company met Wall Street expectations when it released earnings and revenue Oct. 25. But although AutoNation delivered 16% sales growth during the quarter, shrinking margins held gross profit growth to a mere 5%. The company’s finance and insurance division, which accounted for more than half of its total gross profit growth, is benefiting from an enhanced focus on subprime lending and bears watching.

I’m particularly concerned about AN’s increasing non-vehicle interest expense, which rose by $5.8 million in the third quarter to $22.2 million. This was due to higher debt balances and likely will weigh on future earnings, too. Gross profit per new vehicle also slipped 14%, in part because of declines in luxury vehicle sales.

AN set a new 52-week high above $48 on Oct. 19, but has retreated 13% since then. Its forward P/E still sits above 15, which is high for its sector, though it’s slightly undervalued on a PEG basis, at 0.86.

Also worth mentioning on the cautionary side: Hedge fund king Eddie Lampert recently sold $34 million in AN shares at about $44[6].

CarMax (NYSE:KMX[7]). CarMax shares got a huge bounce last month after a report from ITG Research said the used-car dealer chain’s revenue would rise 17% this quarter. While that’s positive for the company, which next reports earnings on Dec. 20, it doesn’t tell the whole story.

KMX’s biggest challenge is the trend toward declining used-car prices. After recent blockbuster growth, the National Automobile Dealers Association now predicts the average price of used vehicles will rise only 1% this year[8]. That’s a stark contrast from the nearly 20% boost used-car prices enjoyed from 2009 to 2010, and the 7.6% rise from 2010 to 2011. Over the past three quarters, KMX’s retail mix of older vehicles — 5 to 10 years old — has risen markedly. Tight used-car inventory is one reason for this: In the past, these vehicles would have been wholesaled, but now the company is putting in the extra reconditioning work to get them up to scratch. This will reduce CarMax’s wholesale volumes in the near term.

Those worries, coupled with high valuations — a forward P/E of more than 17, and a PEG of 1.64 — are reason enough to avoid or sell the stock at this point. KMX’s easy money might be behind it for right now, and without a dividend, there’s little to buffer against any backslide.

As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.

Endnotes:
  1. at an annualized pace of 14.3 million vehicles: http://www.reuters.com/article/2012/11/01/us-auto-sales-idUSBRE8A011120121101
  2. as many as 100,000 vehicles: http://www.edmunds.com/about/press/a-silver-lining-from-a-dark-cloud-damage-from-hurricane-sandy-could-help-economy-and-auto-industry-says-edmundscom.html
  3. LAD: http://studio-5.financialcontent.com/investplace/quote?Symbol=LAD
  4. PAG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PAG
  5. AN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AN
  6. recently sold $34 million in AN shares at about $44: http://www.valuewalk.com/2012/11/eddie-lampert-sells-nearly-34-million-of-autonation-shares/
  7. KMX: http://studio-5.financialcontent.com/investplace/quote?Symbol=KMX
  8. the average price of used vehicles will rise only 1% this year: http://www.nadafrontpage.com/NADA_Used_Car_Guide_October_2012.xml

Source URL: http://investorplace.com/2012/11/car-dealers-2-stocks-to-drive-2-to-park/
Short URL: http://invstplc.com/1nvFC5C