AutoNation: Profit Off Overpriced New And Used Car Market (NYSE:AN)

Car parked at parking lot of the airport for rental. Aerial view of car parking lot of the airport. Used luxury car for sale and rental service. Automobile parking space. Car dealership concept.

Fahroni

We give AutoNation (NYSE:AN) a rating of buy. Although it may seem like a short-term buy to lock in on the high-priced auto market, we believe they will continue to grow.

The auto market is wild right now, and there’s no doubt that dealerships have cashed in on these profits; AutoNation is no exception. They are one of the largest auto retailers in the United States that also sells parts and services, they continue to expand their business by opening new locations and extending their brand with AutoNation USA, and they offer a very diverse group of vehicles at competitive prices including domestic cars, import cars, and luxury cars. Despite some forward-looking growth rates that seem concerning, AutoNation is well fit to survive a potential recession, and will continue to draw in and retain customers even after a recession ends and the car market returns to normal.

AutoNation is an auto retailer based in Fort Lauderdale, Florida, that offers new cars, used cars, and associated services such as collision repair and maintenance. They also offer financing through their third-party financing sources as well as comprehensive coverage plans. AutoNation is a very large auto retailer and was he first retailer in the U.S. to reach 8 million cars sold. As of June 13th, 2021, AutoNation operates 314 locations in the United States spanning across 18 states and 118 cities. Florida, Texas, and California have the most locations.

A Weird Time in the Auto Market

This past year has been a rather crazy one for the automobile market. New cars are hard to find or there are large markups on them, mostly due to the chip shortage which has caused some manufacturers to have to idle their plants for weeks at a time. At the end of September in 2021, AutoNation had about 5000 new vehicles in inventory. Around the same time in 2019 they had 56,000. Not only have the prices for new cars gone up because of this, but used car prices have gone up as well. Some used cars are even selling for over their original MSRP.

CEO Mark Jackson said, “This is a result of the pandemic and then the chip shortage” and that “Vehicles come in and they go right away.” In the past, dealerships have had issues with cars that stay on the lot too long and don’t sell. But now, they can barely get them to stay ON the lot. Jackson also said that 60% of cars AutoNation ordered from manufacturers were marked as sold before they even arrived at its dealer.

There are multiple reasons for the surge in prices such as low interest rates, low supply/high demand, and inflation in the U.S. This may be bad for the consumer but for AutoNation it is ramping up profits. From 2020 to 2021 AutoNation’s Revenue increased from just under 20.5 billion dollars to almost 26 billion dollars, a 26.75% increase. Gross Profit also increased a large amount from 3.5 billion to almost 5 billion. Net Income grew from 381.8 million to 1.37 billion, a 259.8% increase.

Although the company’s profit has increased, this isn’t the only reason you should buy AutoNation stock. The company is well-established, has good financials, and is valued at a great price despite inflation in the current economy and an overvalued stock market. They are a huge company and a trusted dealer to buy from, also offering options for financing and providing comprehensive coverage plans.

Future Business Plans: AutoNation USA

AutoNation recently opened two new AutoNation USA stores in Charlotte, North Carolina and Charleston, South Carolina. AutoNation USA is a used vehicle sales and service center that is an extension of their existing brand aimed at leveraging AutoNation and capturing a larger portion of the used vehicles market. The companies plan to open 12 new AutoNation USA stores by the end of the year, and by 2026 AutoNation plans to have over 130 AutoNation USA stores in operation.

One of the key elements in AutoNation USA is their “One Price” formula. This formula allows the company to take advantage of many different centralized prices and appraisals to offer customers a better and more stress-free buying experience. Another big part of AutoNation is AutoNation express, which allows customers to search for a vehicle, reserve a vehicle, value their trade, see payment options and apply for financing all online. AutoNation USA also offers express service and scheduled maintenance and repair services, allowing for digital communication and payment options. In addition to being able to trade in your car, you can also sell your car directly to AutoNation without purchasing another vehicle.

AutoNation USA is a way for AutoNation to continue to build on their existing brand. It makes sense that AutoNation is investing time and money into opening these new locations. Not only will AutoNation USA help gain new customers, but their service center will help retain these customers by offering repairs, maintenance, and express service. We think AutoNation USA is a great addition to the existing brand.

Recent Earnings

AutoNation released their Q1 2022 earnings report on April 21. Earnings per share was $5.78 and beat analyst estimates by 52 cents, a 103% percent year over year increase. Revenue for the quarter was 6.75 billion compared to 849 million in Q1 of 2021, increasing 14% and beating analyst estimates by 245.35 million dollars. Net Income also increased from 239.4 million in Q1 of 2021 to 362.1 million in Q2 of 2022, an increase of 54%. Profit margin have sharply increased for new vehicles but used vehicle profit margins have declined. Although used vehicle sales have increased 47% the profit margin for AutoNation had dropped 10%. AutoNation said its profit on new vehicles has more than doubled since Q1 of 2022, reporting an average profit of $6,112.

As mentioned earlier AutoNation also provides parts and service for their customers, and it makes up around 14.5% of their revenue and about 32.5% of their gross profit. Profit margins on parts and service rose to 45.9% over a year-to-year basis, and revenue from parts and service rose from $851 million to $1 billion dollars for AutoNation in Q1 of 2022 (up from $851 million at the same time last year). AutoNation CEO and director Mike Manley reported in their recent earnings call that “our service and parts business is clearly showing the benefits of both increased miles travel and our focus on increasing our penetration into the after sales market.”

We believe the most important factor for AutoNation’s parts and service center going forward is being able to bring in and retain new customers. They are going to be able to achieve this by offering things such as complimentary vehicle sanitization and 24-month road hazard protection on tires they sell. They have upfront service pricing (you pay what you are quoted at and nothing more), free multi point inspections, tire pressure checks, and vital fluid checks, and offer financing on vehicle repair. Potentially the most important element of their parts and service business is the fact their work is guaranteed for 12 months or 12,000 miles, whichever comes last.

Going forward, these benefits and services are going to increase the number of AutoNation’s customers AND retain them. Zacks equity research predicts that in Q2 of 2022, AutoNation’s parts and service gross profit will increase from $461 million to $477 million, a 3.5% increase. We believe parts and service is an important part of AutoNation’s success, and it will continue to help increase profits for them in the future.

Revenue from financing and insurance rose from $313 million in Q1 of 2021 to $363.9 million in Q2 of 2022, a 16.3% increase. Zacks equity research predicts gross profit will rise to $371 million in Q2 of 2022, a potential 1.95% increase. Although this operation only makes up about 5.5% of their revenue mix, it is important for AutoNation to be able to get their customers approved and offer them comprehensive coverage plans. With AutoNation you can get instant auto long preapproval that won’t impact your credit score; It is very convenient and easy to go through AutoNation when buying a car. We believe that the AutoNation’s large national reach and the convenience of buying a car through them is going to drive up revenue for this sector of their business.

Inflation, rising gas prices, and rising interest rates have all put pressure on consumers trying to find a new or used automobile. Despite this pressure, demand for new and used cars has increased and although demand has increased year over year, AutoNation (like many other dealers) hasn’t been able to acquire the inventory to keep up with that demand. Add the chip shortage to this list of problems, and you get what you have right now; New cars selling for way over MSRP, record prices for used cars (some even much higher than their original MSRP), and a lot less of them on the lot.

Valuation

When it comes to AutoNation’s valuation, they have very good metrics across the board. But there are some metrics that are concerning when you look at them on a forward-looking basis. They also have some portions of their growth and profitability that are concerning; However, AutoNation is cheap despite these certain metrics.

To start, AutoNation has a very low TTM P/E ratio of 5.78 and a FWD P/E of 5.25, which is very low for their sector and industry. They have a TTM price to sales ratio of .32 and a FWD price to sales ratio of .26. These ratios indicate that in the future earnings and sales will increase for AutoNation. Although AutoNation has great valuation metrics, their price to book ratio is quite high for their sector. They have a TTM price to book of 3.16, but on a forward-looking basis this ratio is 2.41. Again, this metric is more attractive on a forward-looking basis. The only metric we see concerning when looking at it on a forward-looking basis is their price to cash flow ratio. Their TTM price to cash flow ratio of 4.15 is significantly lower than their FWD ratio of 6.22. This indicates that in the future, AutoNation’s cash flows may decline; We would expect this to happen if there was a recession. When things return to normal and car prices go back down, AutoNation will not be able to bring in as much cash as they are now. Although cash flows may decline, this should not stop you from buying AutoNation’s stock.

It may seem as though AutoNation is in a good position to grow, but there are some growth metrics investors should be concerned with. Their year over year revenue growth is 23.43% while their forward revenue growth is 11.95%. This percentage is much lower on a forward-looking basis and indicates AutoNation will continue to grow but at a much smaller pace. Their year over year ROE growth is 91.13%, while their FWD ROE growth is 40.18%. These are both great ratios for their sector, but once again investors should know that AutoNation’s growth will slow down in the future. Potentially the most concerning growth metric is their FWD free cash flow per share growth, which sits as -34.19%. At the same time their year over year operating cash flow growth rate is 7.68% which is decent, but on a forward-looking basis this rate is -6.65%. Their FWD looking cash flow growth metrics indicate a large decline in cash flows in the future. As mentioned earlier, their TTM and FWD price to cash flow ratios also indicate a decrease in cash flows. Almost every forward-looking metric for AutoNation indicates there will be a decline in their growth, and investors should be cautious of this.

AutoNation also has some concerning pieces regarding their profitability, but most of their metrics are very good. Their TTM profit margin of 19.95% is much lower than the sector median of 36.89%, but when compared to other dealerships this metric is quite good. The only other dealership stock with a higher profit margin is Asbury Automotive, who has a TTM profit margin of 20%. AutoNation’s profit margin is higher than Lithia’s, Penske’s’, and Group1 Automotive’s’. Although they stack up against dealerships well regarding profit margin, their CAPEX/Sales ratio is not as attractive. With a ratio of .87, AutoNation ranks near the bottom of the automotive retail industry. This indicates that AutoNation is not acquiring as many fixed assets as other companies; But as mentioned earlier, AutoNation is still expanding their brand with new locations and AutoNation USA and investors should not be too worried that they are not investing in new assets.

The good parts of their profitability metrics include their returns on common equity, total capital, and total assets. These ratios are 54.01%, 17.07%, and 15.98% respectively. All these ratios indicate that AutoNation knows how to profit and knows how to make fantastic returns on their equity, capital, and assets. Investors should be confident that AutoNation will be able to make returns with what they have.

Despite some concerning forward looking growth rates and profitability metrics, we still rate AutoNation as a buy. The most concerning part investors should beware of are their cash flows, which will inevitably decline if a recession hits and demand decreases. They will also have declining profit in the future as supply of cars begins to increase and the Auto Market goes back to normal. We believe that even if a recession hits AutoNation will be able to not only survive but continue to profit and grow, but at a much slower rate. Investors should also keep in mind that AutoNation had been growing before the car shortage increased prices, and that their profits have been boosted largely by inflation and the increase in new car prices; But AutoNation is not done growing, they have a fantastic outlook, and a strong financial position.

Potential Risks & Downside

There are a few things investors should be careful of when thinking about buying AutoNation’s stock. Inflation is high, the car market is experiencing abnormally high prices, and supply is down. As mentioned earlier, there are also some key metrics that could affect the stock price and performance of the company in the future.

With inflation around 8.6%, car dealerships are sure to bring in more profits because they can charge more for their cars. Add that to the chip shortage and overall vehicle shortage, and you have a recipe for an overpriced car market. When things return to normal, dealerships are not going to be able to charge as much money for these cars and their profits might decline a great deal.

The country be headed into a recession. If we head into a recession, demand for cars will fall and sales will decline for AutoNation. Although this is a serious threat, AutoNation is well prepared or an economic downturn. They currently have $608 million dollars in cash to go along with $9.36 billion dollars in total assets; if sales declined sharply, AutoNation would not be in any danger of going bankrupt. People will also continue to service their cars even during a recession, and AutoNation will continue to grow parts and service sales as this section of their business will be relatively unaffected. Even if prices and sales decline, AutoNation has been growing their cash flows since 2018 from $132 million to $1.45 billion. In the same timeframe, net income has grown from $396 million to $1.5 billion. Investors should be cautious of a potential recession, but we believe AutoNation is in a strong financial position and will easily survive a potential downturn in the economy.

As mentioned above, there are many looking growth metrics seem concerning. Investors should beware of their forward-looking cash flow growth rates, as we predict they will decline in the future. Almost every growth metric for this company is expected to decline on a forward-looking basis.

Their profit margin seems low but when compared to other dealerships it is quite high, which should not scare investors; But their low CAPEX/Sales ratio is something to consider when buying this stock.

Conclusion

Overall, we believe that the key metrics to look at when considering the future health of the company are a few of their forward-looking growth rates mentioned above as well as their profit margin and CAPEX/sales ratio. Other than these metrics, we believe AutoNation has very good financials and will rise in price despite dropping from its all-time high of $130 since last year in October. They have a good business model that includes parts and service as well as insurance, they have the ability to profit (especially in this current market), and they have well thought out plans for the future of their business.

AutoNation is one of the United States largest auto retailers. They currently have a fantastic valuation, and their stock is backed by a very good company; both on the operating side and financial side of things. They’re not only one of the best auto retail stocks to buy, but they’re also one of the best consumer discretionary stocks. The way the current automobile market is behaving right now makes AutoNation one of the best stocks to buy, and investors should get in before it’s too late.

Based on AutoNation’s last earnings report, future business outlook, valuation, growth metrics, profitability metrics, and current automobile market behavior we reiterate our rating of buy. Although they may slow down when things go back to normal, we still believe they’re going to continue to grow in the future as a respectable rate, as well as continue to grow their business by opening new dealerships and obtaining new customers. AutoNation is a fantastic company with great financials and a solid recent earnings report; They will continue to be one of the best dealerships even as inflation goes down, supply increases, interest rates rise, and the automobile market goes back to normal.