3 Auto Retail Stocks to Buy on Earnings Growth

Masam is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.

US car sales (shown by the US SAAR) have been electrifying in 2012. Despite a bearish outlook on the economy, sales surged to historic levels. In this case, there are some auto retail players that I want to highlight that will best benefit from a surge in car sales.

Pep Boys (NYSE: PBY): Despite bearish sentiment from the Street, which reflects longer-term structural issues, Pep Boys has a decent setup for 2013. It struggled in 2012 as tires and the core business weakened and the company faced distractions from nearly going private, as well as unfavorable weather. Even though the company’s most recent quarter saw gross margins begin to turn, the Street believes that the top-line stabilization still remains the critical investment question. There is no doubt that Pep Boys has competitive disadvantages in the DIY (Do-it-yourself) space, and competition in the service channel remains intense. However, the company has the opportunity to benefit from some margin catch-up due to the weakness last year from temporary distractions. That and the company’s buyback could insulate it for the next quarter or two. Credit Suisse has a target price of $9 on the stock.

CarMax (NYSE: KMX): CarMax is one of the Street’s favorite 2013 ideas. The crux of the current bullishness is the convergence of improving supply, expenses from new store growth peaking, and immature stores entering and elevating the comp base. These factors are expected to set the stage for mid-single to high-single digit used comps and 20% EPS growth in the future. Calculations show $0.18-0.23 of upside to the 2013 consensus estimate of $1.87. For 2014, the earnings power may be as high as $2.50. Against a P/E multiple of 20, which is below the historical average, that would make CarMax a $50 stock.

AutoNation (NYSE: AN): AutoNation screened relatively attractively as a 2013, idea but its recent Q4 EPS reaction removed a decent amount of the upside. Although AN shares trade at a premium to its peer group, a modest premium seems reasonable given the company’s scale advantages. Trading at 15 times forward earnings, AN is sitting at among the lowest spreads versus the dealer group in a while. I continue to like the auto dealer segment as the recovery in new vehicle SAAR is still playing out.

The Fiscal Cliff resolution is a minor near-term risk, but there are multiple factors that should help new vehicle sales growth get past the hurdles. These factors include a high replacement need, given the nearly 11 year average age of cars on the US roads, new vehicle innovation, fuel efficiency, and most importantly, expanding credit. AN also has some internal tailwinds it should benefit from next year, as the final phase of its shared service center comes on board. Adding up these factors, AN is capable of growing earnings at 20% next year, which combined with its lower multiple and seemingly ‘exceedable’ estimates, makes it a decent name to own for 2013.

Foolish Bottom Line

My article reveals this fact that along with tailwinds for improving macro signs, some auto retailers are expected to grow internally. 

AnalystX has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy. Is this post wrong? Click here. Think you can do better? Join us and write your own!

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