2023-07-25 12:30:21 ET
Summary
- I maintain a hold rating for AN due to expected weak earnings in the near term.
- AN's new vehicle sales are recovering, but the used vehicle segment is underperforming due to inventory shortages.
- I expect AN to continue trading at a depressed forward PE multiple until earnings growth improves.
Investment action
I recommended a hold rating for AutoNation ( AN ) when I wrote about it the last time, as I expected volumes to remain a short-term challenge leading to a possible slowdown in growth in FY23. Based on my current outlook and analysis of AN, I reiterate a hold rating. I expect earnings to remain weak in the near term, which will continue to put pressure on valuation.
Basic recap
AN is a U.S. auto retailer. In addition to selling new and used automobiles, trucks, and SUVs, as well as offering service contracts, auto financing, and repair services, the company also sells parts and accessories for these vehicles.
Review
AN's reported earnings per share of $6.29 are higher than the $5.90 predicted by consensus. Used unit comps and GPUs [gross profit per unit] both did poorly, which was to be expected. GPUs were reported at $1.9k, while unit comps were down 13%. However, new GPUs and unit comps fare adequately.
The recovery of new vehicles’ performance has shifted the spotlight to this segment. Increases in same-store sales volumes of new vehicles of 7% y/y and decreases in GPUs of 24.4% y/y to $4,611 herald the start of the recovery/normalizing growth in sales volumes and a moderation in GPUs. Despite a slight sequential decline in ASPS from the record high of the first quarter to $52,564, it is interesting to observe that there is still some pent-up pandemic demand as only about 40% of units are selling at MSRP. I take management's remark that domestic brands' inventory mixes are now above average compared to luxury brands' mixes, which are closer to the overall average, and import brands' mixes, which are below average, as an indication of the local brands' expected demand.
Changing back to the sluggish performance of the used comp. As the company continued to have trouble finding inventory at prices that were profitable, used comparable volumes dropped by 13.1% year over year. Management acknowledged that self-sourced sales accounted for 90%, which was below internal goals, and signaled an increased focus on buyer ad spend to support self-sourced volumes going forward. In spite of the challenging affordability environment, I anticipate volumes to begin recovering at the beginning of FY24 due to an increase in trade-ins with new vehicle purchases and a rise in demand for used vehicles. Used supply is likely to recover, but I still anticipate near-term headwinds.
The F&I results were a surprising takeaway. Increased focus on products bundled with new vehicles helped F&I per unit hit a record $2,815 and boost same-store revenue by 3.7% year over year. I'd add that the rate of attachment is clearly rising, as evidenced by the fact that there are now more than two contracts for every vehicle sold. Parts and service revenue also did well, increasing 9.1% year over year. I anticipate this trend to continue as AN continues to benefit from the disproportionate demand for auto maintenance. This area of AN's business, in my opinion, is inherently counter-cyclical, and as such, it can help compensate for potential weakness during down cycles. The 2Q23 earnings call also suggests that AN is currently underutilizing its service capacity. Which means there is still a lot of room for improvement / performance in this segment as volume recovers.
“ So if you took active customers, including service, the actual percentage of active customers in the 11 million is well below 50%, well below 50%.” 2Q23 earnings call .
Valuation
Simplywallst
AN is trading at 6.8x forward PE today, a discount to its peers (Sonic Automotive, Penske Automotive, Asbury Automotive, and Group 1 Automotive) in the same industry. I believe the market values the industry based on expected earnings growth, given that these players have predictable levels of profits. On this basis, I believe AN will continue trading at a discount since I expect earnings to remain weak in the near term.
Author's work
I believe AN will see flat growth in FY23 as Used vehicle performance remains weak while New vehicle volume continues to offset that weakness. Thereafter, I expect a conservative growth assumption that the business will regain its historical rates. Margins should gradually revert back to historical levels of low-single digits as the benefits from the COVID surge end. AN should continue to trade at this depressed forward PE multiple for the near term as earnings growth remains weak.
Risk and final thoughts
As new vehicle volume performance is offsetting the weakness seen in the used vehicle segment, this puts the business at a major risk as the current brittle economic environment could further hurt discretionary spending, i.e., lesser new car demand.
I reiterate my hold rating for AN based on the near-term challenges the company is facing. While the recovery of new vehicle sales is promising, weak performance in the used vehicle segment, inventory shortages, and challenging affordability environment continue to pressure earnings. The strong performance in F&I and parts/service revenue provides some counter-cyclical support, but it may not be sufficient to offset the current headwinds. Given these factors, I expect AN to continue trading at a depressed forward PE multiple until earnings growth improves.
For further details see:
AutoNation: Near-Term Earnings To Remain Weak, Pressuring Valuation