AutoNation an Idea for Speculators
Steve is a member of The Motley Fool Blog Network -- entries represent the personal opinion of the blogger and are not formally edited.
The domestic automotive dealership industry is characterized by intense competition, low returns on invested capital, and low cash flow generation per dollar of revenue. Additionally, the companies in the industry, including AutoNation (NYSE: AN), CarMax (NYSE: KMX), Penske Automotive Group (NYSE: PAG), and Sonic Automotive (NYSE: SAH), are cyclical and very sensitive to job and housing markets, which have been the laggards in the domestic economy. However, when the economic cycle is trending up and when individual companies are creating value over a defined period of time, there is opportunity for speculative investors.
CarMax and AutoNation have significant scale advantage over Penske and Sonic and this will perhaps benefit them when an economic recovery takes hold. CarMax and Penske have more diffuse revenue sources compared to AutoNation and Sonic, which have a heavy concentration of sales from California and Florida. AutoNation generates almost half of its revenue from these two states while Sonic is at just less than 30%. The industry has seen recent average used car selling prices and average fleet age at record levels, which has supported results so far in 2012.
CarMax, with a market capitalization of more than $6 billion at the recent $27 share price, is forecast to grow earnings per share by 8.0% next year and trades at a forward price to earnings to growth (PEG) multiple of 1.6x while AutoNation, which has a market cap just less than $5.0 billion at the recent $39, trades at a forward multiple of 1.2x assuming forecast 12% EPS growth. The two smaller companies, Penske and Sonic, both trade at a forward PEG multiple below 1.0x, with estimated EPS growth of 10.6% and 13.3%, respectively. Penske & Sonic offer the added attraction of a dividend, which CarMax and AutoNation do not. Currently, Penske yields 1.7% and Sonic yields 0.7%.
Growth Drivers
CarMax has an aggressive new store opening plan that aims to increase store count to between 152-167 by 2017 from the current 112 stores. Also, CarMax’s growth should be supported by increased same store sales as almost a third of its stores are less than 5 years old and these stores should benefit from the consumer vehicle purchase cycle of 3 to 5 years.
AutoNation achieves its growth primarily through acquisitions and it will benefit from its steep leverage to the economies of California and Florida once they fully recover.
Penske, which has a more than $2 billion market capitalization, has less exposure to used car dynamics than CarMax and AutoNation and it relies on acquisitions and increasing parts & service revenue for its growth.
Like AutoNation and Penske, Sonic, which has a market capitalization of less than $800 million, has grown mostly from acquisitions but the forward growth rate will depend more on profit margin expansion as the company has indicated that it will use cash flow to reduce debt and purchase store location real estate in lieu of acquisitions for the next several years. Revenue is projected to increase by less than 6% while EPS are expected to grow by more than 13%.
Now What?
CarMax and AutoNation have led the group with returns on invested capital of 11.3% and 6.5%, respectively, over the past 10 years, with Sonic and Penske lagging at 3.7% and 3.6%, respectively. Because the returns on invested capital for these companies are weak relative to other more dynamic and growing industries, investors seeking exposure to the auto dealership industry should do so as a short-term speculation rather than as a long-term or defensive position. And as a speculation, AutoNation is poised to leverage a sizable scale advantage once the economic expansion gains steam and that advantage will lead to its shares outperforming competitors.
AutoNation is the best of breed with operating cash flow as a percentage of revenue at 2.8% and 2.5%, respectively, over the past 5 and 10 years. CarMax is clearly less desirable at its current share price with its weaker historical performance and higher forward PEG valuation. And despite the current lower PEG multiples for Sonic and Penske, I prefer AutoNation as a speculation on the improving fortunes of California and Florida.
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