|Shares Out. (in M):||33||P/E||16.0x||12.0x|
|Market Cap (in M):||436||P/FCF||15.0x||11.0x|
|Net Debt (in M):||538||EBIT||101||110|
Asbury Automotive is a cheap stock, trading around 6.5x normalized earnings and offering 50% upside. Asbury is the 6th largest automotive retailer in the country with $3.7 billion in sales and a strong regional presence in the Southeast. Asbury has an attractive brand mix, with only 13% exposure to the domestic automakers and the vast majority of that being to Ford (the only domestic automaker likely not to be a share donator in the coming years). Midpriced imports account for 64% of its exposure (25% Honda, 11% Nissan, 10% Toyota) and Luxury brands account for 23% of exposure. This brand mix is attractive because for several years the midline imports and luxury brands have been taking share from the domestic automakers. Asbury new car sales have been hit about 40% from peak to trough, roughly inline with the industry. Sourcing 28% of revenues from Florida has not been a help to the topline either, although there are reasons to believe the Florida has hit bottom. While the company only earned 82c in 2009, peak earnings were $2.01 in 2007. While 2007 benefited from being a peak auto sales year in the US with over 16 mm units sold in the US, it is likely that Asbury would only need a SAAR (annual sales number) of about 14.5 mm units to achieve that level of earnings power now, due to substantial cost cuts made during the recession (which was really more like a depression for auto sales, as auto unit sales dropped approximately 40% in two years).
Background - Company and Industry
As way of background, in 2007, 16.1 mm cars were sold in the US. In 2009, 10.3 mm were sold, and that included the benefit of the Cash for Clunkers program, without which the units sold would have been closer to 9.5 mm. 2008 and 2009 were clearly extremely difficult years for the auto makers, as evidenced by the bankruptcies of General Motors and Chrysler. They weren't much easier years for the auto dealers. Fortunately for Asbury and the other auto dealers, they were able to count on their parts and service business to maintain profitability throughout the downturn. Auto dealers make money four ways: selling new cars, selling used cars, getting a fee from their financial services partners for originating finance and insurance business, and fixing and providing replacement parts for cars both on and off warranty. The car business is extremely low margin, with gross margins generally ranging from 6-8% depending on the dealer, make and model. The used car business isn't much better, with a 10-12% gross margin under most conditions. Moving new and used cars helps drive the more profitable businesses, which are the F&I (finance and insurance) business and parts and service business. The F&I business is essentially an agency business with 100% gross margins, although the level of transactions and thus revenues is directly proportional to cars sold. The parts and service business is only partly a derivative of cars sold - while most of the business is going to come from car owners who bought their car at that dealer, service volumes are the function of unit sales over several years (generally they have a monopoly on service work for the first three years while a car is under warranty, and thereafter they have to win their revenue though price and service levels). While volumes were under pressure in the service business, Asbury was able to maintain a 50% margin in that business in 2009.
Things were very bleak in late 2008 and early 2009 when the pace of the fall off in auto sales left Asbury (was well as the other auto dealers) too long inventory, and they had to clear cars at a loss in order to get inventory inline, get rid of stale (old model year) inventory, and generate cash. Asbury lost money in 4Q08 and barely made any money in 1Q09, which led to a liquidity crisis (which has since been resolved), a stock price that bottomed at $2, and at one point a going concern note on their filings (also since resolved). By 2Q09 however, through a combination of cost cuts and inventory reductions, the company was again profitable. This pattern of losing money in 4Q08, stabilizing in 1Q09 and returning to better profitability by mid 09 was common to all the auto dealers. It is notable that Asbury and its cohort all returned to profitability by 2Q09 thanks to cost cuts and getting the inventory glut behind them even though the retail SAAR DID NOT IMPROVE from 4Q08 to 2Q09 (4Q08 was 8.3 mm, 1Q09 was 8.2 mm, and 2Q09 was 8.2 mm). The fact that ABG could go from -2c in eps in 4Q08 to making 22c in 2Q09 is evidence of the amount of cost cutting they went through. While some of these costs will come back (advertising, some store level personnel, corporate benefits), others will be permanent (e.g., moving the corporate office from New York City to Atlanta, corporate G&A cuts), which means the company should be able to get back to peak profitability at a SAAR of around 14.5 mm, which is a level I would call a "normalized" SAAR. They will not need a 16-17 mm SAAR to get back to $2 in earnings.
Normalized Earnings Power
The path to $2 in earnings at a SAAR of 14.5 mm is laid out below:
In 2009, ABG sold about 62 thousand new vehicles and the SAAR was 10.3 mm. At a SAAR of 14.5 mm, they should sell about 40% more vehicles assuming constant market share. This 40% bump may be conservative because of 1) their favorable brand mix, and 2) the fact that Florida (28% of sales) was a big drag on the way down and may at some point prove to be a tailwind once it recovers. A 40% bump to 62 thousand new cars would mean they sell about 24 thousand more new cars. In 2009, they sold 40 thousand used cars, yielding a 2/3 used car to new car ratio. So we can assume they sell an additional 16 thousand used cars in the normalized scenario, for a total incremental car sale count of 40 thousand for new and used. The gross profit on a new or used car generally runs about $2000. The F&I revenue (and gross profit, given 100% margin) on a car sold runs about $1000. Of course there will be some variable costs that come with the incremental sale of a car, including salesperson commission. Of the $3000 in additional gross profit per car sold, about $1250 should drop to the operating income line, which yields almost $1 in incremental earnings per share at a normalized sales run rate.
40,000 new cars X
$1250 operating profit per car =
$50 million incremental pretax profit
Less 37% taxes ($18.5 mm) =
$31.5 mm net income
Divided by 33 mm shares =
95c incremental eps
ABG lost $2 mm in 2009 on their non-core heavy truck business. They acquired this business in conjunction with the purchase of a group of Atlanta-based auto dealers and probably should have divested it at the time since it was non-core and there are no synergies to the core business, but it was profitable so they kept it. This is an Atlanta-based operation that sells heavy vehicles to municipal and corporate clients (e.g., school buses, dump trucks, 18 wheelers, delivery trucks, etc.). Sales in this business were down 20% in 08 and 40% in 09, and they were caught long inventory going into the recession. Unlike with passenger cars and light trucks, it was a lot harder to move inventory in this business through discounting, so the business is still in pretty bad shape. This business probably made $2-3 mm in good times, and now it is losing $2 mm. Getting this business back to just breakeven, is good for another 6c/share.
Additionally, Asbury's fixed expense ratio (defined as SG&A as a % of gross profit) has historically run about 200 bp higher than its peers because until recently Asbury was run in a decentralized manner, as opposed to consolidating corporate functions and using a single IT system as its peers do. Since joining the company in 2008, CFO Craig Monaghan (more on him below) has been working to centralize these functions. Centralization, standardization, and IT upgrades probably offer around $10-15 mm of pretax upside, which equates to 20-30c of additional earnings power, although realizing this earnings power will be a several year process.
I therefore calculate the normalized earnings power of ABG to be around $2. They would make more at peak SAAR, but for valuation purposes I will assume a normalized or midcycle SAAR of 14.5 mm.
82c per share 2009 earnings
95c per share from normalizing unit sales
6c per share by eliminating losses in the heavy truck business
20c in additional SG&A efficiency initiatives
$2.03 total normalized earnings power
The smaller cap auto retailers have traditionally traded at 9-10x, thus I think Asbury is worth $18-20 on normalized earnings.
Timing of Recovery
While it is impossible to say when the SAAR will recover, there are reasons to believe it will be sooner rather than later. At an installed US auto base of 200+ mm cars on the road, selling cars at a 10 mm cars/year rate implies that cars will be on the road for 20 years before being replaced. A more normal historical scrappage rate would imply an average car life of 14 years, and a SAAR of 14+ million cars/year. There are quantitative indicators that point to the potential for SAAR recovery such as positive GDP growth and better retail sales numbers. Also, the increasing availability of consumer credit should benefit car sales. A particular credit-related benefit to Asbury is the increasing availability of lease terms for luxury cars. Because of its heavy weighting in the luxury segments, the greatly reduced availability of lease finance was a big headwind for Asbury. Just recently, lease finance seems to be loosening up. While no one can predict when a good SAAR month is coming (I would say any monthly SAAR of 11 million or higher would be received extremely positively and a big catalyst for Asbury and the other auto retailers), I think there is a chance we see a good number at some point this spring, possibly even as early as March. Sales in January and February were hurt by both the very inclement weather (no one shops for a new car in the snow) as well as the constant barrage of negative headlines about the Toyota recalls that began in late January and continued through February.
It is worth nothing that Craig Monaghan, who joined Asbury as CFO in May 2008, is the former CFO of Autonation (AN), the largest and also the most efficiently run public auto retailer. Monahan served as CFO of Autonation from 2000-2006, and was responsible for putting in many of the systems and best practices that allow Autonation to be the efficiency and profitability leader in the industry today. So while centralizing a decentralized company is a tall order, especially in challenging times, Asbury has the best possible person leading this effort. Monaghan was hired to centralize and restructure the company, but ended up spending his first 12-18 months stabilizing the company from a financial perspective, since the auto industry went into a nose dive shortly after he arrived at the company. At this point, the company is in a secure financial position with $85 million cash on hand and $158 million borrowing capacity, so Monaghan is free to focus on the initiatives he originally came to Asbury to implement.
The free "Toyota put"
It is impossible to say what is going to happen to Toyota's market share in the face of the massive recall effort underway addressing the unintended acceleration problem. It seems that Toyota has fought back hard and is doing a good job of maintaining market share since introducing 5 year/0% financing programs in early March. For the foreseeable future, it is clear that Toyota is willing to pay up to maintain its share. If the recalls however end up permanently damaging the brand, or the recall turns out to be broader than the current mechanical issues and the electrical system of the car turns out to be at fault, Toyota may eventually cede share. It is generally thought the most likely beneficiary of Toyota share loss would be Honda, with the secondary beneficiaries likely being Nissan and Ford. Asbury is 25% Honda, which is more exposure than any other public auto retailer. It has an additional 11% exposure to Nissan (also high) and 6% to Ford (average to low). So while it is impossible to say at this point if Toyota is going to lose US share, it is pretty clear that if they do, Asbury will benefit, and you aren't paying anything for that.
The primary risk to Asbury is a double dip recession which prevents a recovery in auto sales. A double dip recession that led to a reduction in the availability of consumer credit would also hurt Asbury.
The parts and service business is currently facing a headwind as the number of cars on warranty continues to decline in line with the 3 year trailing SAAR. Warranty work comprises about 16% of sales in the high margin parts and service business. Asbury and the other public auto dealers are all embarking on various marketing programs to increase customer pay work to offset the drag of the decrease in warranty work. This risk will probably be mitigated for the industry through 3Q10 by the increased amount of recall work related to the Toyota, Nissan and GM recalls.
SAAR recovery leading to earnings recovery
Possible Toyota market share losses/Honda market share gains
|Subject||RE: Balance Sheet|
|Entry||03/22/2010 10:02 AM|
They are about 4x leveraged. I calculate net debt exclusive of floor plan debt, and I calculate EBITDA exclusive of floor plan interest, since floor plan debt is essentially an asset-backed, inventory finance program sponsored by the OEMs. The OEMs would not pull this and it is tightly related to inventory, so I don't look at it in the same way I look at the general corporate debt.
You are right this is a leveraged company. Net debt exclusive of floor plan is 538 and EBITDA prior to floor plan interest is about 135, so it is almosst 4x leveraged. They did in fact get themselves in trouble with the debt in late 2008 when car sales dropped so precipitously and suddenly. I have comfort they are OK now becausse they have $243 mm in cash and borrowing capacity right now, and they should be free cash flow positive from here forward, exclusive of acquisitions, which are discretionary. There are no substantial maturities until 2012, at which point, they should be closer to normal earnings, even if the SAAR recovery turns out to be slower than I expect.
The leverage is here as a result of this being a roll-up business. All the auto retailers have substantial debt on them because of the business model. If you are uncomfortable with 3-4x leverage, then this subsector probably isn't for you (and you should probably read my MGM short write-up, because the leverage is more than twice as high there!).