STLA - Lithia Motors And AutoNation: 2 Interesting Ways To Play The Auto Strike

2023-09-26 15:23:21 ET

Summary

• The UAW strike against the "Big Three" automakers continues, with General Motors and Stellantis facing an expanded strike.
• Automotive retailers like AutoNation and Lithia Motors may benefit from the strike as they have larger inventories of new and used vehicles.
• AutoNation's strong parts and services operation also could contribute to its success in an environment where more used vehicles are purchased and kept longer.
• While Lithia Motors benefits from significant inventory levels that could boost cash flows if prices rise.

For better or worse, this nation has been shaped a tremendous amount by unionized labor. Although the percentage of workers in private industry that are unionized has declined in recent decades, unions still have a significant amount of influence over certain aspects of the economy. In recent years, things like inflation, tight labor markets, and high interest rates, not to mention supply chain shortages, have all created a tremendous amount of economic uncertainty. And it's during times of economic change that unions seem to push for improvements for their members the most.

At this moment, the UAW is one of the largest unionized forces in the country. It boasts around 400,000 active members, plus more than 580,000 retired members, all spread throughout the US, Canada, and Puerto Rico. Although it's significantly smaller than it was at its peak in 1979 when it had 1.5 million workers , it still has the potential to wield tremendous influence on behalf of those that it represents. Since Sept. 15, some of the members at the UAW, nearly 13,000 in all, have been on strike . Their focus has been on what is known as the "Big Three" of the domestic automotive market. These companies are Ford ( F ), General Motors ( GM ), and Stellantis ( STLA ).

At this point in time, it does seem as though Ford is making some headway in its discussions with the UAW. However, the same cannot be said of General Motors and Stellantis because, on Sept. 22, the union announced that it will expand its strike against both of these firms at 38 locations across 20 different states. This means that another 5,600 employees from the Big Three will join the ranks of their brethren in pushing for higher wages and better benefits.

While multiple articles could be written about this particular topic, with each one having a different emphasis, the purpose of this article is to focus on firms that are one step removed from all of this drama. These would be the automotive retailers that ultimately sell the vehicles produced by the manufacturers to the masses. In particular, I've decided to focus on five such firms. These are Group 1 Automotive ( GPI ), Sonic Automotive ( SAH ), Asbury Automotive Group ( ABG ), AutoNation ( AN ), and Lithia Motors ( LAD ). While the first of these, Group 1 Automotive, is a company that I currently own shares in, what I found in my research is that the two companies that will likely benefit the most and stand up to the pain the most common should these strikes expand and last longer, happen to be the latter two, AutoNation and Lithia Motors.

A play on continued pain

At this point in time, I have not seen any reliable data that suggests how much automotive production has already been affected by current strikes. Given that these are targeted strikes at only some facilities, it can be said that some domestic output is still taking place. Having said that, the longer the UAW is picketing, the worse the situation will get. My goal, then, was to try to find one or two automotive retailers that would likely hold up the best during this pain, should it become prolonged.

In an ideal world, this analysis would include a look at the exposure that each retailer has to the Big Three. Some of the companies that I listed above do provide this data. As an example, Asbury Automotive Group stated very clearly that, in 2022, 30% of its revenue came from Big Three firms. Lithia Motors , meanwhile, gets about 27% of its revenue from them. In the case of Sonic Automotive , we get not estimates for the Big Three but, instead, estimates for exposure to overall domestic production. That figure is 17%. 28% of the revenue generated by AutoNation comes from Big Three firms. For my favorite automotive retailer, Group 1 Automotive , the number comes out to roughly 20%. It is worth noting that all of these numbers refer only to the new vehicle sales. But if we are talking about a strike, those would be impacted before anything else.

In one sense, this already gives us our first data point. Admittedly, this is not a perfect comparison given the domestic exposure not necessarily equating to Big Three exposure. But there will be significant overlap. What this initially tells us is that Asbury Automotive Group, AutoNation, and Lithia Motors are technically more exposed, while both Group 1 Automotive and Sonic Automotive have less exposure. Some might view this as sufficient enough to determine which companies would perform best in this environment and which ones would be the worst off. But I would argue that vehicles are typically substitutes for one another. If the price diverges significantly between a Ford and a Toyota, for instance, to a degree that would not normally occur, a consumer that might prefer a Ford would very easily opt for a Toyota instead.

In the event that this strike becomes prolonged, the first thing that we should see would be the prices of Big Three vehicles increase. But if demand becomes scarce enough, those prices will rise enough to encourage customers to switch over to other brand names. Having greater exposure to Big Three vehicles could provide an initial shock to automotive retailers. But this is only if those automotive retailers don't have significant inventories of those vehicles on their books.

Unfortunately, none of the companies provide inventory estimates by brand. But in the chart above, you can see the days’ inventories of new vehicles for each of the five companies that I am looking at. You can see not only for the most recent quarter, but also for the same time last year. In the same chart, you can see the same thing but for used vehicles. When it comes to the new vehicles, the first thing that I noticed was that Lithia Motors has significantly greater inventories on its books today. In fact, it has 59.4% more, relative to how much it sells per day, than the next highest player. The same holds true when it comes to used vehicles. For those not familiar with this concept, the 51 reading that we get for new vehicles for Lithia Motors refers to the number of days' worth of sales that company has sitting at its dealerships or in transport. The 58 reading that we get for used vehicles means that it has about 58 days' worth of sales on that front.

This immediately establishes Lithia Motors as a prime prospect in my book. Ironically, my own darling in the space, Group 1 Automotive, it's actually sitting near the low end of the spectrum on new vehicles and it is up there with the rest of the pack when it comes to used vehicles. Given the ranking that we get between these five automotive retailers, you might think that Asbury Automotive Group would be another quality prospect. In addition to being tied with two of the others when it comes to used vehicles, it has the second highest inventory levels when it comes to new vehicles. However, the other company that I would point to as a leading candidate is actually not that, but is, instead, AutoNation. While the company is the lowest when it comes to new vehicles, an argument could be made that the spike in pricing that should be seen should these strikes worsen will lead to more used vehicles being sold over new ones.

Our prime target, Lithia Motors, has a tremendous amount of inventory when it comes to used vehicles. But AutoNation matches both Asbury Automotive Group and Group 1 Automotive. But these operations are not all about vehicle sales alone. These are complex companies with many working parts to them. And while the sale of new and used vehicles is the most significant driver of value for shareholders, other activities are also incredibly important. One example would be service and repair work, as well as the provision of parts. We can call this "parts and services."

To keep this analysis simple, I stripped away other ancillary revenue sources for these companies and focused only on new and used automotive sales, as well as parts and services revenue. In the first half of the 2023 fiscal year, AutoNation generated $2.24 billion in revenue associated with these activities. This was 45.1% higher than what Lithia Motors generated during the same window of time, despite the fact that Lithia Motors actually sold 28.8% more new vehicles and 16.4% more used vehicles than AutoNation did. In fact, between these three core revenue sources, 17.8% of AutoNation’s sales came from parts and services activities. The next highest was Asbury Automotive Group at 14.9%, or $1.04 billion.

From a profitability perspective, parts and services is incredibly important. This is because the margins associated with it are quite high. The gross profit margin for AutoNation, for instance, stood at 47.1% during the first half of the 2023 fiscal year. To put this in perspective, the gross profit margin for the company's new vehicle retail sales was only 9.2%, while for used vehicle sales it was 7%. While car sales bring in the revenue, parts and services bring in a lot of the profits.

Over the past several years, the average age of a vehicle on the road in the US has increased significantly. Back in 2003, for instance, the average for a vehicle was 9.7 years, with passenger cars at 9.9 years. Today, those numbers are 12.5 years and 13.6 years, respectively. In the event that the strike situation worsens, it's highly probable that many consumers will opt to further extend the time they have with their existing vehicles as opposed to selling them and buying something significantly more expensive. And the longer you keep a vehicle on the road, the more work you will ultimately need to have done to it. So given the exposure that AutoNation has to the parts and services space, I would say that it makes a fantastic prospect to consider for those worried about the near term.

Some of you may think that I'm placing too much emphasis on the possibility of this situation lasting for an extended period of time. But I don't think so. The fact of the matter is that some strikes can last a very long time. If we take the period from 1993 through the present day, and we looked at the 20 longest stoppages across all major industries, we would see that nine of the 20 lasted more than a year. This is not to say that there's a guarantee of the strike lasting a long time. Despite the tremendous amount of time dedicated to those major stoppages, the average strike over the past 30 years that involved more than 1,000 workers lasted only five weeks. So we very well could see this come to an end shortly. But it's always best to assume the worst and plan for it rather than be surprised in a negative way.

Takeaway

Based on the data provided, I would argue that while there's a tremendous amount of uncertainty in the current environment, there could be some interesting opportunities. Automotive retailers like Lithia Motors that have large inventories of both new and used vehicles could experience a boon because they are able to raise prices for a time that will see many of their competitors face inventory issues earlier on. If we enter day 40 of little to no new vehicles coming on to the lot, Lithia Motors will still be able to generate significant cash flows from the inventory that it purchased at a lower price, while competitors might be forced to dole out significant amounts of cash just to keep cars on their lots. This could put Lithia Motors at a rather nice advantage. Meanwhile, AutoNation also makes for an appealing prospect. Although its new vehicle inventory levels are the lowest of the five firms, it boasts a fantastic parts and services operation that should do well in an environment where more used vehicles are purchased and/or where existing used vehicles are kept by their owners longer.

It should be mentioned, however, that if the strike lasts several months, this picture could change. Naturally, revenue could eventually fall if inventories run dry. It's unlikely that other car manufacturers can or would increase production enough to offset declines from elsewhere because of how much that would cost. While the AutoNation angle is more resilient to this than the Lithia Motors angle is, it's hard to know what will happen if the strikes expand and stretch into day 100 or day 200. Robust cash flows from selling other vehicles could prove to be a boon for these companies, but there's also likely a breaking point at which consumer buying grinds to a halt. So playing at all in this space does bring with it certain risks.

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