Summary
- AutoNation sees its stock reach an all-time high. At the same time, JPMorgan's analyst sidelined the stock with a sell rating.
- AutoNation is not rapidly growing. Furthermore, keep in mind that AN's profit margins are contracted by approximately 110 basis points y/y.
- AutoNation is a cannibal story. What's a corporate cannibal?
Investment Thesis
AutoNation's ( AN ) Q4 results put a cap on a very strong finish to 2022. This was a period where AN repurchased 25% of its stock. Reminding investors that businesses that actually make strong free cash flows and use it wisely can substantially increase shareholders' ownership in the business simply by staying along for the ride. This makes AN a cannibal stock. A cannibal company is a company that uses its free cash flow to consistently buy back its stock.
The stock is not expensive at 8x forward EPS. But there's more to this story than immediately meets the eye.
Revenue Growth Rates Are Not Strong
The graphic above is a useful reminder that despite AN's stock jumping 50% in the past year, the strength of the stock's outperformance hasn't come from strong revenue growth rates.
In fact, as you can see, AN's revenue growth rates after Q1 2022 have barely averaged a 2% CAGR. Hardly the sort of growth rates one would expect from a stock that's now at an all-time high.
This saw JPMorgan (JPM) rapidly sideline the stock on an equivalent sell rating.
Fully Focused on Profitability
AN saw its bottom line EPS figure increase 11% y/y. That being said, keep in mind that AN's adjusted operating margins fell from 8.1% in last year's Q4 to 7.0%, a 110 basis point contraction.
On the other hand, AN's focus on free cash flow led AN to repurchase a quarter of its business in 2022. This is a remarkable feat that few multibillion-dollar businesses ever achieve. And those that do, fewer still succeed in doing so in a short twelve-month period.
And then, to truly impress upon readers that this is not a one-off event, keep in mind that since the end of 2020, AN has bought back more than 40% of its outstanding shares.
Furthermore, even though there's significant seasonality in the business, with higher sales of Premium Luxury vehicles, which have higher average selling prices and gross profit per vehicle retailed in the fourth quarter, I'm still unsure of whether analysts' consensus expectations looking into 2023 are not on the low side.
Indeed, Consider this:
SA premium
What analysts are expecting from AN is for the business not to return to the $6.37 EPS that it reported in Q4 2022. In fact, looking ahead to next year, analysts are expecting an 18% drop in its EPS figures.
Even if I buy the argument that AN is going to substantially slow down buying back its shares, in preference to reinvesting in the business, I still struggle to see how between now and Q4, its EPS figures drop by 18%?
Further, this is what AN stated during their recent earnings call ,
Thus far in 2023, we have purchased an additional 800,000 shares with more than $1 billion of remaining share repurchase authority.
Even if AN slows down its capital allocation toward share repurchases, and Q1 only sees $220 million of capital allocated towards repurchases, and even if 2023 as a whole only sees AN buy $500 million worth of stock, which would be about a third of the capital used in 2022, I still struggle to reconcile a reasonable estimate with an 18% drop in EPS by Q4 2023.
AN Stock Valuation -- 8x forward EPS
As AN contended throughout its earnings call, its balance sheet is in strong shape, going so far as to state,
Our current leverage ratio of debt to EBITDA of 1.6 times remains well below our historical 2 times to 3 times range.
Thus reinforcing that although the business isn't growing at a fast rate, it will be able to continue to lean on its flexible balance sheet plus strong cash flows to both invest into the business and buy back stock.
The Bottom Line
AN is a corporate cannibal. The sort of company where it pays to have a slightly longer time frame to invest and know that you'll be rewarded as your proportion of AN increases with time.
For further details see:
AutoNation: Driving What Matters, Cannibal