Description

We recommend purchase of Asbury Automotive Group (ABG), one of the largest auto dealer groups in the United States.

• 8.5x 2021e EPS of $13 – recently completed Park Place acquisition accretive by $2.50 p/s annually
• EBITDA actually increased YOY during pandemic impacted Q2, demonstrating a resilience in the model
• Pro forma for Park Place, more profitable/resilient luxury brands are 50% of revenue 

ABG is an exceptionally well managed, highly shareholder-oriented company.  Having demonstrated its resiliency through the pandemic, with the ability to do highly accretive M&A and a growing mix of more stable luxury revenue, we think the current P/E multiple is far too low.  With $9 billion of annual revenue (AutoNation has $20 billion of revenue – Lithia $12.5 billion) there is a long runway to grow via acquisition in a very fragmented market.  

Manatee wrote up Asbury on 2/18/20.  It is an excellent read.  We are updating the story post Q2 pandemic earnings and completion of the Park Place acquisition.

Description.  Pro forma for the recently acquired Park Place Dealerships, Atlanta, GA-based Asbury Automotive owns 91 dealerships in 9 different states.  New vehicle revenue by geography is: 32% Texas, 30% Florida, 12% Georgia, and 26% other (IN, NC, SC, MI, CO, VA) – we assume this is roughly the breakout for total revenue as well.  Luxury brands make up an impressive 49% of revenue with imports at 34% and domestic at 17%.

The auto dealer story is likely known to VIC members. ABG stats are below:

• Gross margins on new cars are 4%, used about 6.5%.  Used market larger, less economically sensitive 
• F&I (finance/insurance) per vehicle sold growing nicely, now $1,700 - effectively 100% gross margin
• Parts and Services 60%+ gross margins, growing MSD, not SAAR related, half of companywide GP
• SG&A is 70%-80% variable - advertising, sales commissions etc.  Can be pulled back very quickly

A couple of interesting points to consider:

• Same store parts & services revenue has grown about 5% annually.  Gross margins are over 60%
• Non parts/service gross profit (used, new, F&I, reconditioning) has grown at 1% annually per vehicle retailed; F&I growth has more than outweighed declining new and used gross profit per vehicle

What this means is that in a flat SAAR year, on an organic basis, gross profit would grow 3% and EBITDA would grow 4% - 5%.  Additionally, ABG could use FCF to accretively acquire additional dealerships (i.e. Park Place).

In a down 5% SAAR year, we estimate that EBITDA would be about flat (we assume flat p/s in this scenario).  Again, in this scenario, FCF could easily be used to grow EPS by acquiring more dealerships. 

Importantly for Asbury, luxury has higher margins, is more recession resistant, and is now 50% of total revenue (we estimate 55% - 60% of EBITDA). 

July 7, 2020 – Park Place Acquisition Call:

The luxury segment has historically delivered strong and stable margins that are significantly above those achieved by midline imports and domestic brands. Luxury stores are most resilient in downturns, have higher and more stable margins, have fewer dealers nationwide and derive a higher portion of gross profit from parts and service.

Q2 Results.  Here is a breakout of Q2 results:  on a same store sales basis

• New car units -23% with revenue -21%.  Used car units -14% with revenue -12%
• Gross margins: new 5.0% vs. 4.0% PY.  Used 8.2% vs. 6.7% PY.  New/Used GP dollars flat vs PY
• Parts and service: revenue -24%, GP -28%.  F&I: Revenue -15%, GP -15%
• Total revenue down 19%.  GP dollars down 17%.  SG&A dollars down 23%
• Floorplan interest expense (included in EBITDA) down from $10.5m to $4m as inventories are down
• Net result is EBITDA of $87m vs. $84m last year

Clearly gross margins were higher than normal and potentially without the stimulus dollars, new/used car units might have been down more.  On the other hand, the parts/service decline was purely pandemic related and not something we would expect to see even in a recession.  The SG&A decline was enormous and not sustainable.  

If you wanted to normalize the numbers somewhat….take Q2 2019 more normalized gross margin to this year’s new/used car revenue, assume parts/service GP down 5%, and assume SG&A down 10% with everything else remaining the same, you’d end up with $76m EBITDA in the second quarter vs. $86m last year. 

Any way you cut it, the model here is far more resilient than it gets credit for.

Financials.  For perspective, 2019 revenue and EBITDA was $7.2 billion and $333 million with EPS at $9.46.  

For 2020, excluding Park Place, after a 10% EBITDA decline in Q1 and a slight increase in Q2 we are assuming about flattish EBITDA in Q3 and Q4.  In a year that we assume new units are down 12% - 13%, used units down about 5%, and parts/service down about 7%, overall revenue would be down about 7% but higher gross margins and lower SG&A would deliver flattish EBITDA and EPS of about $335 million and $9.30 per share (again, all before the Park Place acquisition impact).  

For 2021, excluding Park Place, we assume growth in new/used units sold and growth in parts/service off a depressed 2020.  Viewing 2021 versus 2019 we assume slightly lower new car revenue, flat used car revenue and increased parts/service, which combined would deliver flat total revenue with a higher gross margin (continued growth in 60% GM parts and services drives overall growth in GM) and lower SG&A due to savings achieved in 2020 – net net we get to $10.50 per share in 2021 EPS with Park Place adding $2.50 per share (see below) for a total of $13 in 2021 EPS.

In a flat SAAR year, we’d assume 10%+ EBITDA growth (organic + M&A). 

Park Place Acquisition.  After initially announcing a deal to acquire Park Place in December 2019 for $1 billion, and then terminating the deal due to the pandemic,  ABG recently completed a revised transaction in which it purchased 12 of the all luxury all Dallas-based Park Place dealerships for $735m (vs. 19 dealerships in the original deal), most of it funded by cash on ABG’s balance sheet.  Park Place is highly thought of in the industry as a premier luxury player with about $75 million of annual EBITDA plus $20 million of expected synergies by year three.

We expect $85m in 2021 Park Place EBITDA.  $5m in D&A, $10m in interest cost and $15m - $20m in taxes (some tax benefits in this asset deal) would generate $50m in net income on about 20m ABG shares outstanding - approximately $2.50 per share.

The transaction will leave ABG at about 3.6x leverage with a goal of getting to 3x by the end of 2021.

Digital Strategy.  Importantly, new car sales are subject to state franchise laws and can only be sold online by local car dealers like Asbury.  

Upstarts like Carvana and Vroom are growing rapidly in the used car space, and are typically selling lower value cars, certainly not manufacturer certified pre-owned cars.  We expect that most of the share taken by the digital players will come from the independent used car segment of the market.    

Lithia (NYSE: LAD) is targeting $50 in EPS five years out from $11.76 of EPS in the base year of 2019.  Lithia plans to double EPS to $25 at its currently owned dealerships, to acquire another $15 in EPS and to generate $10 in EPS from its new Carvana like used car online platform called Driveway.  The market gives a 14.5x 2021e P/E to Lithia because of its aggressive M&A targets and its online potential.  

Asbury is not trying to create a Carvana-style online business, but it is very focused on improving the online experience at its existing dealerships.  In fact, 20% of its used cars were sold entirely online last quarter.

Summary.  Asbury is in no man’s land, there’s no sexy digital strategy and no aggressive M&A targets – just a well-run, high margin, shareholder-oriented, resilient cash machine business with an excellent luxury mix selling for 8.5x earnings.

Lithia’s publicly disclosed long-term targets and its resulting industry high multiple are likely to compel Asbury’s management to offer long term targets as well.  Asbury isn’t likely to create another Driveway, but it could offer a more aggressive M&A target/plan going forward.

For the record, the large historical buybacks at ABG were driven by previous CEO Craig Monahan (formerly the CFO at Eddie Lampert influenced AutoNation).  ABG’s current CEO David Hult is more focused on M&A as evidenced by the recently completed Park Place transaction.  As you can see with Park Place, M&A in this space can be incredibly accretive so more of it certainly makes sense.  At only $9 billion of revenue, Asbury can grow for years to come. 

The move to the suburbs / avoid public transportation / low interest rates are here for a while - these trends are likely supportive of healthy levels of auto sales going forward. 

Catalyst

More aggressive M&A