AN - AutoNation

[kab60]

Surprised there wasn't a thread. Mecham bought a small position in Q4, Lambert is a major shareholder (has been selling, maybe redemptions?) and Buffett seems to like car dealership. So what's not to like?

 

Obviously, this is a cyclical business, but it's been growing nicely since the financial crisis by buying dealerships and at the same time half of the shares has been repurchased.

 

Per Morningstar analyst estimates it's trading around 10 x 2018 PE. No idea if that includes a share count reduction of some 20 pct. in the next two years if history is any guide.

 

Not a fabolous business with ROIC around 10-11 pct. but with some leverage ROE has been twice as high in recent years and it's not too shabby to reinvest earnings at that rate (snowball baby!). Cash flow positive every year (2007 included, don't have older data).

 

No idea if leverage is too high for some, but it seems they free up cash when crisis hits (selling down inventory?) so I suppose they have liquidity levers to pull if car demand plummets.

 

Positive catalyst would be a reduced tax rate, since these guys pay around 38 pct. in taxes.

 

Pretty shallow analysis, but I'm inclined to take a position.

 

I know Tesla sells directly, but I.don't see dealerships becoming obsolete, or am I missing something (I surely am, but anything significant?)

[whistlerbumps]

Key part of this business is aftersales which generates a lot of the GP and is much more stable than new/used.  Long-term there are some legitimate risks to this cash flow stream from electric cars (fewer moving parts=less service) and self-driving cars (fewer accidents =less service, fleet like nature means less profitable).

 

Overall though I think dealers are a better biz than people give them credit for.  Hope that helps.

[atbed]

Key part of this business is aftersales which generates a lot of the GP and is much more stable than new/used.  Long-term there are some legitimate risks to this cash flow stream from electric cars (fewer moving parts=less service) and self-driving cars (fewer accidents =less service, fleet like nature means less profitable).

 

Overall though I think dealers are a better biz than people give them credit for.  Hope that helps.

 

Still getting my bearings in this space, but I've been doing some work on the accident rate as well. In addition to self-driving cars, tech like Automatic Emergency Brakes (AEB) could have a notable impact on accidents in the next few years. Automakers have agreed to roll it out by 2022 and some studies predict a significant reduction in collisions (up to 40% in some cases).

 

My guess is that AEB could actually come sooner than 2022. Toyota, for example, is rolling AEB on most Toyota/Lexus models by 2017. Many higher-end cars have some form of AEB standard or as an option. We could see AEB move down market more broadly sooner than 2022. 

 

U.S. DOT and IIHS:

http://www.iihs.org/iihs/news/desktopnews/u-s-dot-and-iihs-announce-historic-commitment-of-20-automakers-to-make-automatic-emergency-braking-standard-on-new-vehicles

 

Volvo:

http://www.iihs.org/iihs/news/desktopnews/more-good-news-about-crash-avoidance-volvo-city-safety-reduces-crashes

 

Toyota:

http://www.autonews.com/article/20160321/OEM11/160329991/toyota-gets-head-start-on-making-auto-braking-features-standard

 

I have been playing around with a model projecting the # of crashes each year. There are a lot of moving pieces (miles driven, stuff like distracted driving), but if we assume 10%, 20%, 30% or even 40% reductions in accidents we could see a noticeable hit. We only replace ~6% of the car park, but AutoNation may feel the impact earlier. I believe much of their collision work is on younger vehicles.

 

That said, I haven't spent much time figuring out what percentage of parts & service is from collision work.

[AzCactus]

I'm not invested in this name and haven't really researched it.  That said, my general thought is that as long humans are in a car they will find some way to crash them. Between phones, alcohol, drugs, low iq's etc.  people will keep being idiots.  Hopefully I'm wrong though. 

[kab60]

Thanks for the replies, guys. I've been puzzling a bit about potential iasues but don't have much to add. Makes sense that EV's will require less maintenance but might it also provide an opportunity, because it's more complicated to repair with all the internal electronics? Thus maybe favoring dealers with scale and a close relationsship with OEM's? I'm inclined to think it will take a long time for EV's to really get traction, but I haven't played with numbers.

[prevalou]

https://www.manhattan-institute.org/html/tesla-and-solar-city-merger-rooted-battery-derangement-syndrome-9026.html

 

this article shows why electric cars will be a luxury for a long time.

 

and EV s nedd maintenance too...

 

https://www.tesla.com/support/maintenance-plans

[mttddd]

Thanks for the replies, guys. I've been puzzling a bit about potential iasues but don't have much to add. Makes sense that EV's will require less maintenance but might it also provide an opportunity, because it's more complicated to repair with all the internal electronics? Thus maybe favoring dealers with scale and a close relationsship with OEM's? I'm inclined to think it will take a long time for EV's to really get traction, but I haven't played with numbers.

 

I think the software component plays in here as well, do you really think Toyota is going to let your neighborhood mechanic update the firmware on your car? Unlikely, instead you will need to go into an authorized dealer for that sort of work. I dont know that dealers will make much off of that if anything but simply getting people in the door opens up all the usual up sell opportunities

[valueyoda]

Autonation is very appealing at these levels.

 

1). Investors are ignoring the excess real estate that could be monetized

2.) Inventory risk is lower than investors are assuming (even though auto sales may decline)

3). Outstanding CEO that has skin in the game; and involved shareholders: Bill Gates (20% ownership) and ESL investments that push the company towards using Autonation's free cash flow for acquisitions at decent valuations and share buybacks

4). It might be an interesting acquisition target for Berkshire Automotive group

[kab60]

I took a position the other day. Appreciate the feedback from everyone. I made a long reply but it got lost one of those days with server downtime. Anyway, I think it will take a looong time before EV's become significant in volume, and while fewer collisions might be a headwind at least there's sort of happiness hedge knowing that fewer people get hurt. Jokes aside, Auto Nation is actually experiencing too little capacity at its collision centers and expects to increase volume 40 pct. I trust managements judgements. That's just one of the growth initiatives however where they're trying to really leverage their brand and digital capabilities; branded parts should add 100m incremental gross profit, and they're increasing their auction sites from 1 to 5 and launching Auction Nation USA to leverage their brand across used vehicles with a no-haggle one-price policy (mimicking/copying Carmax?). I also like their capital allocation options; buy other dealerships (little integration risk) when it makes sense and/or buyback stock when that's more valuable. And then they have the aforementioned growth initiatives as well (500m capex) which they expect a higher return on than buying dealerships.

[WneverLOSE]

Does anyone by any change have acsess to a premium morningstar account and can post here the analyst report on AutoNation ?

This is the link to the report : http://analysisreport.morningstar.com/stock/research?t=AN&region=usa&culture=en-US&HID=QUO_STK118

By the short snipet you get as a non member user on their website the report seems it might be interesting "We believe AutoNation's massive size and economy of scale advantages will allow it to deliver operating margins at times above 4%, though not on an annual basis until its AutoNation..."

 

[Guest roark33]

AutoNation reported first-quarter EPS of $0.97, up 8% year over year and comfortably more than consensus of $0.91. EPS received a boost from a gain on legal settlements with automakers, so we calculate EPS of about $0.85 excluding other income. Flat revenue of $5.1 billion missed consensus of $5.3 billion, while same-store revenue increased by 0.3%. Same-store parts growth of 3.2% could not offset a 0.6% decline in same-store new-vehicle revenue. Same-store gross profit per new unit fell by 2%, probably due to incentive pressure, while same-store used GPU fell by 24% as the company took a beating on used-vehicle pricing in order to move vehicles that had previously been on stop-sale from manufacturers because of the Takata airbag recall. We see these results as more evidence that our prediction of new-vehicle industry volume peaking last year being correct. However, we are raising our fair value estimate to $49 from $43 as a result of Morningstar’s expectation of the U.S. statutory tax rate falling to 25% in January 2018. Our moat rating remains narrow.

 

We still think U.S. new-vehicle demand will remain at healthy levels in the low 17 million unit range this year, so we do not think an automotive recession is imminent; however, incentive levels, a surge in vehicles coming off-lease, and April new-vehicle inventory at 4.2 million units, its highest since 2004, make further growth in new-vehicle sales this year unlikely in our view. This growth had to end eventually, which is why AutoNation over the past few years established a single AutoNation brand for its stores, which then laid the groundwork for the AutoNation USA dedicated used vehicle stores. AutoNation USA’s first two locations open in the second quarter in Corpus Christi and Houston, Texas. Selling, general, and administrative expenses as a percentage of gross profit will be high by AutoNation standards in 2017 at over 72% (72.6% in the first quarter), but we think the investment now will pay off over time.

 

 

Investment Thesis 04/25/2017

We believe AutoNation's massive size and economy of scale advantages will allow it to deliver operating margins at times above 4%, though not on an annual basis until its AutoNation USA stand-alone used vehicle stores are more established. In 2013, the company rebranded all of its 15 regional brands to the AutoNation brand name. A single brand should be more effective for Internet searches, and it lets AutoNation reduce fees to third-party search firms.

 

This branded strategy is now extending to collision centers, parts, and AutoNation USA. The U.S. used vehicle market is about 40 million retail units a year. More square footage will allow AutoNation to retail more of its used vehicle trade-ins rather than dump some cars into auctions where it loses money. It also allows the company to recapture service revenue from vehicle owners who no longer go to the dealer for service. The challenge for AutoNation will be in obtaining accurate pricing data so it can effectively source from its exclusive inventory channel of trade-ins from its approximately 260 franchise stores.

 

The company mitigates some risks with its sheer size and resulting economy of scale benefits. Selling, general, and administrative expenses excluding rent are often below 70% of gross profit, and AutoNation outperforms the industry average. This superior cost structure allows the company to post above-average operating margins even in weaker economic times. Also noteworthy is the company's sizable dealer network within its large markets, which enables AutoNation to quickly reallocate inventory to better meet demand.

 

New vehicles make up about 57% of AutoNation's sales but only 19% of gross profit. Parts and service was only 15% of 2016 revenue but constituted 43% of gross profit. This significant contribution to profitability is less volatile than new- and used-vehicle sales and will continue to mitigate the cyclical risk of the auto industry. Large dealers like AutoNation are enjoying an increasing competitive advantage for repair work because most automakers require warranty work to be done at a dealer. Also, increasingly advanced automotive technology presents an obstacle for smaller repair shops.

 

Economic Moat 04/25/2017

We are maintaining our narrow moat rating, as AutoNation's size continues to generate economies of scale and working-capital efficiencies while the service segment's warranty work gives the company an intangible advantage over garages. A large dealer such as AutoNation can move inventory around to different stores within a market where it will be in most demand, something a small dealer with just one or two stores in that same market cannot do. We think the dealer sector is the best business in the automotive supply chain. The public dealers can centralize back-office operations and generate far more volume than a small dealer, which brings scale. Dealers have no burdensome retiree expenses, and the large public dealers are not dependent on the health of one brand. The dealers enjoy mid- to high-single-digit gross margins on new vehicles and 100% gross margins on financing and insurance. We think the best source of competitive advantage is the parts and service operations. Many customers bring their vehicle to the dealer for servicing, either because the vehicle is under warranty or the dealer is close to home and has the factory parts and expertise to service the vehicle. Once vehicle owners know a dealer, we think they are likely to keep going back to the dealer for service. The dealer knows the vehicle, and comparison-shopping for repair work is very time-consuming, as the customer has to bring the vehicle to each shop to get a quote. These cost advantages and intangible advantages from service give dealers a moat.

 

These logistics create inelasticity of demand, which creates pricing power for the dealer and is a source of excellent profit in good times and bad. In fact, during a downturn in new-vehicle sales, dealers generally report higher gross margins due to a favorable mix shift to parts, but then report lower operating margins due to selling, general and administrative, or SG&A, deleveraging. Excluding large impairment and restructuring charges, dealers can still report positive EBIT even in a severe recession. Although most dealerships are good businesses, we think the large publicly traded dealers are best positioned for growth since they can be the most flexible in changing brand mix. In 2016, the largest 150 dealer groups owned 19% of all U.S. dealerships and sold 21.6% of all new vehicles, up from 21.2% in 2015.

 

AutoNation may further its advantage over smaller dealers with its AutoNation Express initiative, which it started in December 2014. Thanks to an IT investment of over $100 million and a single established national AutoNation brand, customers can select a vehicle online with a price given online, and reserve the vehicle with a credit card for 48 hours. The customer then comes to the store and takes a test drive. For a cash deal with no trade-in, the customer can leave in their new vehicle within 30 minutes.

 

In 2015, AutoNation enhanced the program so that the customers receive a trade-in offer online. After self-reporting the trade-in's condition, the customer can then fill out a loan application online and see loan offers, buy online F&I products such as an extended warranty, and will eventually be able to sign documents electronically at home to further reduce time in the store. Pricing will be no-haggle. This type of project can only be completed by the largest dealers who are well-capitalized via large credit lines and the equity market. A much more traditional retail experience should also prove more attractive to millennial customers, who will also be searching online, where AutoNation is the only franchise dealer with something close to a national brand.

 

Valuation 04/25/2017

We are raising our fair value estimate to $49 from $43 due to Morningstar’s expectation of the U.S. statutory tax rate falling to 25% as of January 2018. Our long-term effective tax rate for AutoNation is now 28.5%, down from 38.5%, with state and local taxes making up most of the difference from the 25% federal statutory rate. Our weighted average cost of capital is now 8.9%, up from 8.4%, due to less interest tax shield. Our midcycle operating margin number including floorplan interest is 3.5%. This level reflects margins that we think can range between about 2.5% in bad times to the low-4% range in good times. We continue to see a healthy growth runway as AutoNation is the largest player in what is still an extremely fragmented yet ever-consolidating sector. We calculate that operating margin including floorplan interest expense for 2016 came in at 3.6%. In our model, if we took operating margin including floorplan interest in the final three years of our five-year explicit forecast period up significantly to 4.5% in each year, our fair value estimate would be about $66. We believe that although the auto dealership industry is a good industry, it is still a cyclical one. However, we think AutoNation's size, its brand, and new digital storefront and shopping experience, AutoNation Express, will enable the company to continue driving market share gains and may provide enough selling, general, and administrative leverage for further meaningful margin expansion in good economic times. We believe the company's cost structure will enhance its scale benefits as vehicle sales improve. We forecast revenue to grow at about a 3.6% rate on a five-year compound annual basis during our five-year forecast period and for U.S. new-vehicle share to reach 2.1% at the end of our five-year explicit forecast period. We expect operating margin, including floorplan interest expense, to average 3.2% and capital expenditures to be 1.6% of sales.

 

Risk 04/25/2017

AutoNation operates in a very cyclical industry and is more prone to revenue volatility than other dealer firms because it has so much cash coming in from California, Florida, and Texas. In addition to housing, other macroeconomic variables, such as gas prices, interest rates, and unemployment, will influence the company's sales. Also, the company relies on acquisitions for some of its revenue growth, so there is always the risk that it will not find enough suitable deals, overpay for an acquisition, or incur problems integrating new dealers. AutoNation USA is a new and expensive initiative that carries execution risk but we are not worried about the strategy failing. In 2012, we raised our fair value uncertainty rating to high from medium in order to be more consistent with the uncertainty ratings of the other dealers we cover. Still, we are confident that AutoNation will remain one of the best operators in the dealer sector and thus be profitable in nearly any economic environment.

 

Management 04/25/2017

AutoNation has bought back more than 400 million of its own shares since 1999 for $8.2 billion. Chairman and CEO Mike Jackson, 68, has been clear in public comments that his first choice with capital, after reinvesting in the business, is to acquire stores, but he is also happy to buy back AutoNation's shares if sellers of stores are asking too much. We are very pleased to see a firm buy back its shares when they are trading well below our fair value estimate, so at times Jackson's move is a good use of capital. However, in more recent times, we have differed with management as to whether AutoNation's shares are underpriced. The buyback program has about $299 million of authorization remaining as of February 2017. We would not be surprised if buybacks slow in order to fund investment for building out AutoNation USA stores. No buybacks occurred in the first quarter of 2017.

 

Jackson became CEO in September 1999 and chairman in 2003, taking the reins from founder Wayne Huizenga, who brought Waste Management and Blockbuster to prominence. Jackson has about three decades of industry sales experience, including many years at Mercedes-Benz USA, where he was CEO from October 1998 to September 1999. On Feb. 1, the company announced the promotion of COO Bill Berman to president and COO. Berman, 50, has been COO since 2015 and previously led the firm’s West Coast operations. We do not think Jackson is going anywhere soon, but we think the promotion helps give investors confidence on a possible succession plan.

 

As of February 2017, about 16.5% of the company is owned by ESL Investments, led by Eddie Lampert, or other Lampert affiliates. Lampert decided not to seek re-election to the board in 2007 in order to focus on his duties at ESL, but as a large shareholder, his priority of maximizing free cash flow and return on invested capital is still present at AutoNation. Lampert materially reduced his stake in recent years. Former ESL president and COO William Crowley had been on the AutoNation board since 2002 but resigned in 2013. Mike Mikan joined the board in 2013 when he was president of ESL, but has been chairman and CEO of private investment firm Shot-Rock Capital since January 2015. If the stock traded at depressed levels for an extended period, it would not be surprising if ESL opted to buy the entire company. Such a move, however, would require approval from the automakers. In 2009, automakers granted ESL permission to increase its AutoNation stake to more than 50%, which ESL did. Microsoft founder Bill Gates holds about a 20% stake, split between his Cascade Investments and the Bill and Melinda Gates Foundation. The Cascade stake is about 18.2%. Michael Larson, Bill Gates' chief investment officer, joined the board in 2010.

 

Overview

 

Profile:

 

AutoNation is the largest automotive dealer in the United States, with 2016 revenue of $21.6 billion and 260 dealerships in 16 states, primarily in Sun Belt metropolitan areas. New-vehicle sales account for about 57% of revenue; the company also sells used vehicles, parts, and repair services, as well as auto financing. The company (formerly Republic Industries) spun off its waste management unit (Republic Services) in 1999 and its car rental businesses (ANC Rental) in 2000.

 

[WneverLOSE]

Thank you very much ! (for the second time now  ;D )

 

I find it interesting the AutoNation is basically the only national player in the US. wouldn't expect it as an outsider.

I really think it gives them a huge advantage with millennials that search the web instead of going the the dealership they knew for 30 years.

AutoNation sales to millennials are rising as a percent of sales and I recon it has to do with the fact they are the only name brand out there.

 

Well I do think it is an interesting stock to think about, if things don't change to much in the future this should be quite a decent return. This is a pretty big if since everyone is talking about autonomous cars, Tesla selling direct and ride sharing services such as lyft and uber.

[Guest roark33]

I am not sure I would count on AN's scale to matter.  AN is the biggest player right now, but that isn't saying much.  They have 260 or so out of over 17,000 dealers.  Buying a car is still a local thing.  Also, TrueCar is making the "national" name brand meaningless as Truecar becomes a better way to search on the internet.  They aren't going to make money on selling new cars anymore, as they have stated, so they are shifting more emphasis to their own after-market parts line and used car dealers.  Even though AN is down since its high, I still don't think it is that cheap.  It's not really a great business. 

[Jurgis]

Ppl just sign up for a public library account that gives free access to Morning*  8)

 

Here's the pointer to discussion and some options: http://www.cornerofberkshireandfairfax.ca/forum/general-discussion/gurufocus-vs-morningstar-vs/msg292601/#msg292601

 

Not that I object to M* report posted here ;)

[Foreign Tuffett]

I am not sure I would count on AN's scale to matter.  AN is the biggest player right now, but that isn't saying much.  They have 260 or so out of over 17,000 dealers.  Buying a car is still a local thing.  Also, TrueCar is making the "national" name brand meaningless as Truecar becomes a better way to search on the internet.  They aren't going to make money on selling new cars anymore, as they have stated, so they are shifting more emphasis to their own after-market parts line and used car dealers.  Even though AN is down since its high, I still don't think it is that cheap.  It's not really a great business.

 

Can you elaborate on why you don't think AutoNation is a great business? I would probably call it good. If nothing else it has generated enough cash flow to cannibalize its share count since CEO Mike Jackson took over in 1999.

 

Basic Shares Outstanding:

 

YE 2000 10K: 337,146,986

YE 2016 10K: 100,913,153

[MrB]

I am not sure I would count on AN's scale to matter.  AN is the biggest player right now, but that isn't saying much.  They have 260 or so out of over 17,000 dealers.  Buying a car is still a local thing.  Also, TrueCar is making the "national" name brand meaningless as Truecar becomes a better way to search on the internet.  They aren't going to make money on selling new cars anymore, as they have stated, so they are shifting more emphasis to their own after-market parts line and used car dealers.  Even though AN is down since its high, I still don't think it is that cheap.  It's not really a great business.

 

Can you elaborate on why you don't think AutoNation is a great business? I would probably call it good. If nothing else it has generated enough cash flow to cannibalize its share count since CEO Mike Jackson took over in 1999.

 

Basic Shares Outstanding:

 

YE 2000 10K: 337,146,986

YE 2016 10K: 100,913,153

 

I would venture it is an average business with a great management. Average because their topline and bottom line is virtually the same in 2000 and 2016. They've probably at least doubled market share, but here they are still selling/earning virtually the same, so scale means zilch. Today they are forced by the OEMs to sell their cars for free and make money elsewhere (Service, parts, finance and used).

In the years you mentioned they spent $2Bn and change to buy out 70% of our (I own a sliver) partners and for that we picked up 70% more in today's FCF, so one simplistic way to look at is it that your return is ($272m in FCF * 70% = $190m/$2Bn = 10%).

Pedestrian over the time frame you mentioned and today we're sitting at the top end of the auto cycle and these guys are venturing into USED where they got a bloody nose before.

 

Nothing too exciting in my view.

[Foreign Tuffett]

I am not sure I would count on AN's scale to matter.  AN is the biggest player right now, but that isn't saying much.  They have 260 or so out of over 17,000 dealers.  Buying a car is still a local thing.  Also, TrueCar is making the "national" name brand meaningless as Truecar becomes a better way to search on the internet.  They aren't going to make money on selling new cars anymore, as they have stated, so they are shifting more emphasis to their own after-market parts line and used car dealers.  Even though AN is down since its high, I still don't think it is that cheap.  It's not really a great business.

 

Can you elaborate on why you don't think AutoNation is a great business? I would probably call it good. If nothing else it has generated enough cash flow to cannibalize its share count since CEO Mike Jackson took over in 1999.

 

Basic Shares Outstanding:

 

YE 2000 10K: 337,146,986

YE 2016 10K: 100,913,153

 

I would venture it is an average business with a great management. Average because their topline and bottom line is virtually the same in 2000 and 2016. They've probably at least doubled market share, but here they are still selling/earning virtually the same, so scale means zilch. Today they are forced by the OEMs to sell their cars for free and make money elsewhere (Service, parts, finance and used).

In the years you mentioned they spent $2Bn and change to buy out 70% of our (I own a sliver) partners and for that we picked up 70% more in today's FCF, so one simplistic way to look at is it that your return is ($272m in FCF * 70% = $190m/$2Bn = 10%).

Pedestrian over the time frame you mentioned and today we're sitting at the top end of the auto cycle and these guys are venturing into USED where they got a bloody nose before.

 

Nothing too exciting in my view.

 

All good, accurate points. I think this is one to watch, but isn't quite cheap enough to buy yet.

[stahleyp]

not a bad write up.

 

http://news.morningstar.com/articlenet/article.aspx?id=820427

[kab60]

Increased buybacks by 250m. Seems like they bought back around 5m shares or 5% of shares outstanding post Q2.

[kab60]

Wow. I like. Bought back 9 pct. of outstanding shares in Q3 and people still buy cars and have them fixed...

[gfp]

Impressive repurchase activity - wish more companies would use opportunities like that

 

Wow. I like. Bought back 9 pct. of outstanding shares in Q3 and people still buy cars and have them fixed...

[Txvestor]

A voracious cannibal.

[NewbieD]

Anyone looking at this?

[kab60]

Not looking much, but it's a 10 pct position for me. Don't expect anything spectacular, but the longer it stays around these levels the better. I think one gets a lot of their bets in brand extension and used vehicles for free, so I like the optionality plus it's a decent business with great management with skin in the game and sound capital allocation.

[glorysk87]

How do you get comfortable with the likely double whammy these guys are facing? First, Auto SAAR has likely peaked, which means a tough road ahead. Second, the number of cars coming off lease in the next 12 months is at an all time high, and the flood of supply that will create will almost certainly hurt used car pricing quite a bit.