Why You Should Play The Auto Sector A Little More Aggressively

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

I recently published an article about CarMax (NYSE: KMX) being a defensive way to play the automotive sector, as a used car business tends to do well during recessionary times as well as good times. Today, I’d like to focus on a slightly more aggressive way to play the sector using AutoNation (NYSE: AN), the largest new auto dealer in the United States. While I still stand by CarMax as an excellent recession-resistant play, if you believe (as I do) that the economic recovery will continue for several more years, read on.

About AutoNation

As the largest auto retail company in the country, AutoNation operates a network of 263 dealerships which sell 32 different manufacturer brands of new vehicles. In addition to its new vehicle operations, AutoNation gets 24% of its revenues from used vehicle sales, 16% from parts and service and 4% from its financing operations. Although many of the company’s dealerships have been operating under local brand names, the company decided in early 2013 that they would unify all of the company’s locations under one brand. 

Auto sales tend to do better as the economy improves (particularly new vehicles), and that is exactly what is expected to happen over the next few years. New vehicle sales are projected to grow by almost 7% this year, according to industry experts, due to both the improved employment situation in the country as well as the gradually loosening credit availability. 

Looking at the numbers…

At 15.1 times this year’s expected earnings, AutoNation seems to be fairly valued right now. Revenues are expected to rise by about 9% annually for the next few years due to a combination of the higher sales volume mentioned above as well as a higher average sales price per vehicle. This year’s earnings per share of $2.94 are projected to rise to $3.29 and $3.65 in 2014 and 2015 according to the consensus of analysts who cover the company. This corresponds to a three-year average annual earnings growth rate of 12.8%, which sounds great given the valuation.

<img alt="" src="http://g.fool.com/editorial/images/54565/an-sales_large.png" />

On the negative side, AutoNation’s sales growth has been fairly inconsistent over the years, as evidenced in the chart above. What this says to us is that AutoNation is very recession-sensitive, and in fact lost $6.89 per share in 2008 as a result of the economic downturn. Additionally, the company does carry a relatively high debt load of about $2 billion, which certainly needs to be taken into account when valuing a company. 

Alternatives: used cars, part suppliers, and auto manufacturers.

As I mentioned before, CarMax is a much less recession prone option. I discuss CarMax’s revenue growth extensively in the article I wrote a few weeks ago, but the company’s sales barely suffered during the recession and have since increased to about 40% more than they were before the economy soured. However, bear in mind that CarMax trades at around 25 times earnings. In other words, you pay for their tremendous growth.

<img alt="" src="http://g.fool.com/editorial/images/54565/kmx-revenue_large.png" />

Another way to play the sector that is relatively recession-proof is through auto parts retailers such as AutoZone (NYSE: AZO). AutoZone actually benefits if both AutoNation and CarMax do badly, as that would imply that consumers are hanging on to their aging cars for longer, as was the case a few years ago. An aging vehicle population means a lot more repair parts are needed. To further illustrate this point, consider that AutoZone’s sales increased every single year over the past decade, whether the economy was strong or not.

<img alt="" src="http://g.fool.com/editorial/images/54565/azo-revenues_large.png" />

Finally, the most bullish way to play the sector is with an investment in one of the automakers themselves, such as Ford (NYSE: F).Ford’s sales are more reactive to the economic climate than the other alternatives discussed here, and plummeted 31.4% between 2007 and 2009. While Ford’s sales have rebounded in recent years, consider that the company’s U.S. market share has been falling lately, down from 11.9% to 10.5% in the last year alone. There are several other choices like Toyota (low risk) and General Motors (high risk), but regardless of which one you choose, realize that this is the most bullish way to play the sector.

Conclusion

After examining several options, I think that AutoNation is an excellent combination of bullishness and defensiveness. On the bullish side, the company makes the majority of its money from new vehicles sales. They also have significant exposure to used vehicle sales and repair, which combine for over 40% of the company’s revenue and offer some protection in challenging times. 


Matthew Frankel has no position in any stocks mentioned. The Motley Fool recommends CarMax and Ford. The Motley Fool owns shares of Ford. 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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