Stick With Used Dealers When Shopping for Car Stocks

by Lawrence Meyers | February 7, 2014 11:01 am

Think hard about this: What was the most obvious element of Super Bowl Sunday’s TV ads? No, it wasn’t the peanut M&M. No, it wasn’t the crazy amount of money spent on some really poor spots. It was the fact that one industry dominated the ad buys.

Car Auto Dealership 300x199 Stick With Used Dealers When Shopping for Car Stocks[1]Cars.

Every other commercial was a car commercial. I turned to my friend, Mike, who was watching the game with me. He sells advertising time for a big network and anticipated my question. “I filled my sales quota for the entire quarter in mid-January,” he said, “and 80% of the ad time was for cars”.

The economy may still stink, but car stocks have had a resurgence since the financial crisis waned. Investors have their choice between new car stocks or used car stocks. I love the used car space, because its margins are much higher.

The overall numbers for the used car industry have been very strong, as folks who need a new car but can’t afford one pick a used car instead. But which of the used car stocks is best? Let’s take a look.

CarMax (KMX)

CarMax (KMX[2]) is first up on our car stocks shopping trip. The company had a terrible commercial on Sunday, but CarMax has an interesting superstore model, with 123 such stores in 61 markets.

What I like about CarMax is that it doesn’t merely sell used cars. It also sells used cars that don’t meet their internal standards to other used car dealers via online auctions, so KMX can still make money if a client offers a garbage trade-in. It also sells high-margin products like extended warranties, repairs, and accessories.

Most of all, I love that KMX also offers financing, because many used car buyers tend to have lousy credit, which means CarMax can hit them for high-interest loans.

Something’s wrong here, however. The company is generating negative operating cash flow, and even more negative FCF. Stop the car. I’m out.

AutoNation (AN)

AutoNation (AN[3]) is a hybrid, offering both used and new cars, along with all those high-margin products. But how does it compare to other car stocks?

I love that AN has a lucrative collision business, as well — if you’ve ever needed repairs after a wreck, you know how expensive fixing collision damage is. AN also has financing and insurance products. I also like that AutoNation deals in premium luxury new vehicles, which are also high margin.

However, the company just reported that retail sales were flat with last year. AN stock is sitting in a better position than KMX, with 18.65% long term growth. On FY14 EPS of $3.38, it suggests fair value is upwards of $60, and currently trades at $49. The company isn’t heavily leveraged, and it has positive FCF. So far, AN stock is looking like the best buy among these used car stocks.

Penske Automotive Group (PAG)

Penske Automotive Group (PAG[4]) could almost be an identical twin to AutoNation as far as what it provides, outside of the luxury market.

PAG is more spread out geographically, with 344 franchises, about half of which are in the U.K. That compares to AutoNation’s 263 franchises in 15 US states. There’s strong growth here, too.

However, that growth is 20% in FY13, 15% in FY14 and 9% in the long term. PAG stock trades at $41, or about 13x FY14 estimates. It has the least leverage of all, at about $1 billion, and while it has positive FCF, that figure is weaker than our other options. PAG isn’t the worst of the car stocks, but AN stock is in better condition. I’ll pass on PAG.

America’s Car-Mart (CRMT)

America’s Car-Mart (CRMT[5]) is the last of our used car stocks.

Looking at its financials, I’m actually going to dismiss it out of hand. CRMT has negative FCF, and has barely ever broken into positive free cash flow. Its forward price-to-earnings ratio looks attractive, but it’s just not worth the risk of that awful cash flow right now.

If things improve, it might be worth looking at because it’s the smallest of the group, which means it may have the most room to grow.

So after shopping around, AutoNation is the hands-down winner for used car stocks. I’m looking to buy in the next 72 hours.

Lawrence Meyers does not own any security mentioned, but intends to purchase AN in the next 72 hours.

Endnotes:
  1. [Image]: http://investorplace.com/wp-content/uploads/2011/05/Car-Auto-Dealership.jpg
  2. KMX: http://studio-5.financialcontent.com/investplace/quote?Symbol=KMX
  3. AN: http://studio-5.financialcontent.com/investplace/quote?Symbol=AN
  4. PAG: http://studio-5.financialcontent.com/investplace/quote?Symbol=PAG
  5. CRMT: http://studio-5.financialcontent.com/investplace/quote?Symbol=CRMT

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