3 Reasons to Buy This Auto Retailer

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

Auto sales in the U.S. are approaching their six year highs, and automobile manufacturers are finally breathing a sigh of relief. Thanks to the low interest rate environment and increasing personal disposable income in the economy, auto recovery seems genuine with robust growth prospects for 2013. To play the recovery, investors can invest in automobile or tire manufacturers, but both the industries involve significant operational risks.

But, auto retailers generally survive on volumetric growth and have minimal operational risks. The company in focus is AutoNation (NYSE: AN), and here are a few reasons why it makes a great investment.

1. Impressive numbers

The company has outperformed major automobile manufacturers in terms of stock appreciation over the last 2 years. This was possible because AutoNation deals in both new and used cars. On a quarterly basis, its new car sales surged 17% against the industry average of 13%, while used car sales inched up 2%. It has also been working on its efficiency and profitability per store, and managed to expand its gross profit per vehicle by 30 bps, leading to an additional profit of $15 million.

Another reason for AutoNation’s success has been its product diversity and geographical expansions. The company derives almost equal share of revenue from its domestic, import, and luxury segments, each of which reported sales growth of 9%, 24%, and 20%, respectively. AutoNation also acquired six new stores during the previous quarter, which took its overall count to 221 stores and 265 franchises selling 32 different automobile brands in 15 states.

2. Investors' delight

AutoNation has been returning value to its shareholders in the form of share buybacks. In 2011 and 2012, the company repurchased 17.1 million shares for $583.4 million and 16.6 million shares for $581 million, respectively. On Jan. 31, it had $319 million worth of repurchase authorization left, which aggregates to pending share repurchase of 7.56 million shares.

These buybacks seem pretty aggressive, and it has reduced its outstanding shares nearly 21% over the last two years. Although, the company doesn’t pay a dividend, it is possible that these repurchases could be clearing the way for dividend payouts in the future. Companies often repurchase their shares to either bolster their EPS growth or reduce their dividend burden, and AutoNation could be doing the same. But it’s just speculation!

3. Estimating growth

AutoNation will be reporting its Q1 FY13 results on April 18. Its closest rival, CarMax (NYSE: KMX), reported its financial results last week, and they can be used to estimate the trend of AutoNation’s upcoming results. For the recent quarter, CarMax reported a 13% surge in its profits, while its revenue grew 14%. Its used car sales rose 12% while gross margin dropped 60 bps. That said, CarMax is currently the largest retailer of used vehicles in the U.S., and its strong growth only paints an optimistic picture for AutoNation.

Penske Automotive (NYSE: PAG) is also a prominent brand, and is currently the second largest vehicle retailer in the U.S. The company is expected to earn $150 to $170 million on the back of improving margins, solidifying market share, and a growing automobile industry. Its shares have appreciated nearly 25% in the last one year, and appear to be undervalued with a forward P/E of 11.8x. But, its debt/equity of 233% is pretty high due to acquisitions.

Now, it wouldn’t be fair to expect similar growth results from AutoNation, but these numbers indicate that auto retailers are not only enjoying higher volumes, but are also expanding their margins. According to analyst consensus, the annual EPS of AutoNation, Penske Automotive, and CarMax should grow 19.8%, 20.1%, and 12.8% for the next five years.

Wrap up

There is no denying that the automobile industry is booming. Rather than investing in an automobile manufacturer, investors can hedge their risks and spread their rewards for a steady growth. Since AutoNation has a diversified portfolio, a good set of fundamentals, and a huge repurchase program underway, I believe that it is a good stock to hold.

Piyush Arora 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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