3 Car Dealers Set to Ride The Recovery

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

In a rebounding auto industry, some dealers like Lithia Motors (NYSE: LAD), Penske Automotive (NYSE: PAG) and AutoNation (NYSE: AN) stand out against the competition.  Whether its scale, the promise of luxury, or location, each offers a unique opportunity.  But the question remains, which is the best of the best?

Sub-Urban Kings

Lithia Motors business model is interesting as it specializes in rural markets for which most big auto dealers take no interest. The key to its success has been a lack of competition, 80% of its stores face no competition in a 50 to 100 mile radius.  Because of this dynamic, Lithia has some pricing power which can be seen by its consistently high gross margins, currently at 16.1%.

Over the past few years, Lithia has outgrown its rural only business, and now owns successful city dealerships.  It has also grown by acquiring smaller dealers that dominated local markets.  Its used car business is lucrative as these cars are usually more than 5 years old but still carry an average gross margin of over 20%.

And it's cheap. Lithia is currently trading at 15 times earnings yet is projected to grow at 25% over the next 5 years.  Going forward, it should benefit from an industry rebound, a strong cash position, and plenty of under penetrated rural markets. 

As big as it gets

AutoNation is the largest dealer in the country, almost doubling the runner up.  It enjoys economy of scale advantages which helps it rake in the cash.  AutoNation is particularly dominant in Florida and California, which contribute almost half of its total revenue.

Several factors have contributed to AutoNation´s margins.  For starters, its size makes its cost structure considerably lower. In addition, its focus on selling parts and services has largely impacted its profits.  Last quarter, the parts and servicing segment was up 8% year over year.  But it accounted for 15.5% of total revenue and 41% of its gross profit.

With roughly $290 million in free cash flow, stock repurchases have been significant.  Like Lithia, the stock is cheap.  Currently its trading at 16 times earnings which is a discount to the industry's average.

But there are some chinks in its armor.  Some concerns have to do with its dependence on the California and Florida markets, its variable rate debt, and its high exposure to new car sales. During the recession, California and Florida was hit harder than other states.  And if purses tighten, new car sales may suffer.

Drive in luxury

Penske focuses on luxury brand retailing and servicing. This characteristic makes it less susceptible to the cyclical nature of the industry as its customers tend to experience lower restraints on their discretionary spending power, even during economically troubled times. Furthermore, these types of cars generally return to the dealer for servicing more frequently than that of lower end models.

Analysts expect the company to deliver an average annual growth rate of around 17% to 18% over the next five years.  Its plan for expansion is a reason for this optimism.  As the industry becomes more competitive, Penske should be able to acquire several smaller luxury dealers.

Overseas expansion is also worth mentioning. Recently, Penske entered the North Irish and Italian markets, adding diversity to its geographic base. International expansion could be a real wild card.

With a 1.9% dividend and a stock buyback program, Penske consistently returns cash to shareholders.  It's earnings multiple around 13 makes it the cheapest of the 3 dealers.  In fact, it's only trading at .2 times sales.

Bottom line

All of the above retailers are interesting, but Lithia Motors may just be the best of the bunch.  Its knack for setting up shop in less competitive areas sets it apart from its peer's.  Its strong margins, growth prospects, and smart management makes it worth a closer look. 


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