2023-11-21 00:58:48 ET
Summary
- Cascade Investment, LLC, managed by Bill Gates, is the largest shareholder of AutoNation owning 23% of the company's shares.
- Eddie Lampert, a hedge fund titan, is the second-largest shareholder with a 12.4% stake.
- AN has achieved strong financial performance and has a track record of outperforming the S&P 500.
- Despite growing EPS at an above market rate over historically, AN trades at a significant discount to the S&P 500.
- I am initiating AN with a strong buy rating.
The largest shareholder of AutoNation Inc ( AN ) is Cascade Investment, LLC, the investment firm which manages the personal investments of Bill Gates as well as the Bill & Melinda Gates Foundation Trust. Cascade's investment in AN was first disclosed in late 2008 and at the time amounted to 9.9 million shares which represented 5.5% ownership in the car dealer. Currently, Cascade still owns ~9.9 million shares which represents ~23% of all AN shares outstanding.
AN's second largest shareholder is hedge fund titan Eddie Lampert. Currently, Lampert owns ~5.3 million shares of AN which represents ~12.4% of all AN shares outstanding though it should be noted that Lampert has recently modestly reduced his stake.
Taken together, Cascade and Eddie Lampert own ~35.4% of AN shares outstanding. While investing alongside well known investors can often be rewarding, I believe investors should always do their own independent analysis.
Business Overview
AN is one of the largest auto retailers in the U.S. The company operates ~343 new vehicle franchises from 247 stores across the U.S. primarily in the Sunbelt region. AN offers a range of products and services including new vehicles, used vehicles, parts and service, and automotive finance and insurance products.
AN sells 33 different new vehicle brands with core brands being Toyota ( TM ), Honda ( HMC ) , BMW, Ford ( F ), Mercedes-Benz, General Motors ( GM ), Stellantis, and Volkswagen.
While new vehicle and used vehicles sales, which account for ~44% and 36% of revenue respectively, make up the bulk of AN's revenue gross profit is more diversified. The company's parts and service business is the largest driver of gross profit accounting for ~36% of gross profit while the finance and insurance business is the second largest gross profit driver accounting for ~27% of gross profit.
AN is well diversified in terms of brands. The company's two largest brands in terms of new vehicle revenue are Mercedes-Benz and Toyota which account for ~15% and ~14.7% of new vehicle revenue respectively.
Franchise Agreements Create Defensible Moat
While the car dealership and service business is somewhat competitive, entrenched players benefit from franchise agreements which offer certain protections from competition and which make it difficult for new players to enter the business.
In order to understand why car dealers enjoy a defensible moat, it is critical to understand how the business developed. By the mid 1920's the automobile manufacturing industry had consolidated into just a few major producers while dealership franchise ownership was much more fragmented with small players. In response, laws were passed in states to protect the dealers from the automobile manufacturers. These laws include certain provisions which given dealerships territorial exclusivity for certain areas. Moreover, the laws also limit market entry for new players.
The result of this has been that the car dealership industry has been able to generate strong historical returns despite the struggles that manufactures such as Ford ( F ) and General Motors ( GM ) have experienced.
Warren Buffett has also signaled his belief that the automotive retail business is attractive when he acquired Van Tuyl in 2015 which was the No. 5 U.S. auto retailer at the time.
Strong Historical Performance
As shown by the table below, AN has achieved very strong long-term and short-term growth rates in key metrics such as revenue, EBITDA, net income, and EPS.
Perhaps the most impressive metric is the 23.5% 10yr EPS CAGR.
This level of financial performance is even more impressive when considering the fact that the auto retail industry is highly mature. Moreover, AN is one of the largest players in the industry.
Strong financial performance has led to strong long-term returns for shareholders. As shown by the charts below, AN has a very strong long-term performance track record compared to the S&P 500. AN has also outperformed over more recent time periods including the past 5 years.
Strong Q3 2023 Results
On October 27, 2023 AN reported Q3 2023 results. AN reported Non-GAAP EPS of $5.54 which beat analyst estimates by $0.04 and. Revenue came in at $6.9 billion, an increase of 3% compared to the same period a year ago, which beat analyst estimates by $190 million.
The company experienced strong growth in both new and used vehicles resulting in the first year-over-year total unit sales growth in eight quarters.
Additionally, on the Q3 earnings call the company highlighted the strong growth in its financing business:
Our 11 million plus customers are our core focus and we're extending our product offerings and reach into more recurring revenue streams and we're adding new customers every day across all of our channels. And during the quarter, we increased the penetration of automation finance at our AN USA stores, where we are now financing roughly one in four AN USA vehicle sales and we have also expanded into our franchise stores. So AutoNation Finance continues to be integrated as a thoughtful and measured place and is, in fact, ahead of where we thought it would be, which is why we expanded it to our franchise businesses.
Opportunity For Further Industry Consolidation to Drive Growth
One of the biggest drivers of strong historical financial performance for AN has been its consolidation strategy. Historically, the company has been an active acquirer of smaller dealerships. In 2021, AN spent ~$433 million on new acquisitions and received proceeds of ~$49 million from divestitures. In 2022, AN spent ~$192 million on acquisitions and received proceeds of ~$55 million from divestitures. For 2023 thus far AN has spent ~$271 million on M&A.
To put this total into context, AN today has a market cap of just ~$6 billion. Thus, recent acquisitions have proved a significant part of AN's business strategy.
AN has said that acquisitions remain a major part of its strategy. The company discussed the benefits of acquisitions in its most recent 10-K :
To better service the personal transportation needs of our customers, we continue to expand our footprint through dealership acquisitions and the expansion of our AutoNation USA stores.
On the Q3 conference call AN CFO Tom Szlosek added additional color on M&A opportunities:
On the M&A front, I do think that opportunities are abundant. The trick is finding the ones that we think are good for our shareholders and where we can run them profitably and add value to the business. And we're very active in looking at all sorts of different opportunities.
Despite significant consolidation in recent years, the industry remains ripe for further consolidation. As of 2022, it is estimated that the top 10 dealerships account for just 8.9% of total U.S. dealerships while the top 150 dealerships account for 23.3% of total U.S. dealerships.
Currently, AN is estimated to account for just ~2.4% of total industry revenue. Thus, I believe AN has an excellent opportunity to drive further growth via continued acquisitions.
Aggressive Share Repurchase Program
As shown by the chart below, AN has been an aggressive repurchaser of its own stock over the past few years. AN's total number of shares outstanding has decreased by ~49% over the past 3 years.
During Q2 2023 , AN repurchased 1.3 million shares for an aggregate purchase price of $200 million. As of October 25, 2023 the company has ~$439 million remaining under its current board authorization for share repurchases. Based on current market prices, the remaining authorization amounts to ~7.3% of shares outstanding.
Valuation
AN currently trades at 6x FY 2023 earnings and 6.7x FY 2024 consensus earnings. Comparably, the S&P 500 trades at 18.6x consensus earnings. Thus, AN is clearly trading at a much cheaper valuation. Additionally, AN has historically grown EPS at a 10 year CAGR of 23.5% while the S&P has grown earnings by ~8%.
In addition to trading at a very attractive trailing and forward P/E ratio, I believe consensus estimates for EPS growth are too conservative. Currently, consensus estimates call for AN EPS for FY 2027 to be the same so FY 2023. I view these estimates as highly conservative for a few reasons. Firstly, AN has grown historical earnings at a much higher clip than this. Second, AN remains committed to its buyback program which the current remaining authorization accounting for ~7.3% of shares outstanding. Once this program is complete, I would expect AN to announce a new buyback given the company's strong history of buying back stock. Finally, the company has multiple potential growth drivers including rising GDP and thus a growing auto market, consolidation of smaller auto retailers, and continued rollout of AN's vehicle financing offerings.
On a relative to peers basis, AN is trading at the very low end of its peer range based on key metrics such as forward P/E, forward EV/ EBITDA, and EV/ Sales. AN's business is broadly similar to its peers, but there are a few notable differences. Group 1 Automotive ( GPI ) is focused on the U.S. market but it also has significant operations in the U.K with ~27% of its dealerships located there. Penske Automotive ( PAG ) also has significant international operations with ~39% of sales coming from outside North America. PAG also stands out due to its large commercial truck dealership business which accounts for ~15% of earnings. Lithia Motors ( LAD ) also has a substantial international business primarily in the U.K. Asbury Automotive ( ABG ) is similar to AN in that it does not have international operations. In September, 2023 AN submitted a preliminary offer to acquire U.K. based dealer Pendragon PLC. However, AN later dropped its bid. International markets such as the U.K. remain a key potential growth driver down the road for AN.
AN currently trades at a significant discount to its average historical valuation on both a P/E/ ratio basis and EV/ EBITDA basis. Thus, I view AN as highly attractive at its current valuation relative to historic norms.
Seeking Alpha
Risks To Consider
I believe the primary short-term risk to my bullish view is that macroeconomic economic conditions worsen and the U.S. heads for a serious recession.
AN is in a highly cyclical business as demand for new cars tends to fall during times of economic weakness. Additionally, consumers may be more hesitant to spend money on services and parts unless repairs are absolutely critical. While an economic downturn would be a short-term negative for AN in that earnings are likely to fall, I believe it would represent a long-term opportunity. Smaller dealerships may be weakened by an economic downturn which would provide AN attractive consolidation opportunities.
Another risk to AN is related to its balance sheet. As of Q3 2023 , AN has $3.94 billion of non-vehicle debt outstanding. While the company's covenant leverage ratio was just 2.0x at the end of the quarter, AN is a highly cyclical business and thus a prolonged economic downturn could lead to balance sheet problems. AN does have a well diversified maturity ladder with only ~$900 million of debt coming due before 2027. Additionally, AN has significant liquidity of $1.6 billion which includes $64 million in cash and ~$1.55 billion available under its revolving credit facility.
Conclusion
AN's two largest stakeholders, Cascade Investments (Bill Gates) and Eddie Lampert, control ~35% of AN shares and are well known investors. While investing alongside well known investors can be rewarding it is not on its own a reason to buy a stock.
AN has delivered very strong results for investors historically. While AN competes in a fairly competitive industry, it does enjoy some competitive advantages due to state regulations which limit competition in certain geographic areas.
AN is one of the largest auto retailers in the U.S. and is able to use its scale to drive efficiency relative to smaller players. Over the past few years, AN has acquired a number of smaller dealerships and plans to continue acquiring smaller auto retailers going forward. Despite significant consolidation in recent years, the auto dealership industry remains highly fragmented. Thus, AN will have additional consolidation opportunities in the years ahead which have potential to drive substantial growth.
AN trades at a significant discount to the S&P 500 despite the company's strong historical financial performance and growth rates. I believe the market is over-focused on the cyclical nature of AN's business (and potential for near-term earnings headwinds in the event of a recession) and fails to consider the significant growth potential due to further industry consolidation. In addition to trading at an attractive level vs the S&P 500, AN is also trading at an attractive relative valuation relative to peers and to its own historical valuation range.
For these reasons, I am initiating AN with a strong buy rating. I would consider changing my view if the stock increases substantially from here.
For further details see:
AutoNation: A Solid Value Stock Buy