Value Investors Club / AUTONATION (AN )

Description

COMPANY DESCRIPTION:

Autonation is the largest national auto retailer, with over 325 locations, sells close to 300k new cars per

year and 250k used cars. Profits are mostly generated in the high margin, recurring revenue Parts and

Services business (45% of GP $) with financing and insurance profits the next largest profit driver,

connected to used and new transactions. The business has been an excellent M&A/roll up business of

private dealers as professional organizations can easily streamline SG&A, customer acquisition, service

and selling processes. Public dealers own less than 10% of the dealerships in the US with significant

room for expansion/consolidation.

THE MACRO:

From the macro perspective, auto retail is in an excellent position to benefit from the quick snap back of

consumer auto demand buoyed by low rates, government stimulus and, somewhat, by fear of public

transportation. In the meantime, auto OEMS shut production for close to 2 months, which took any

excess supply out of the market. Supply of high margin, high value new trucks and SUVs are unlikely to

catch up with demand for 3-6 months. The used market is benefiting from lack of quality new and

continues to benefit from rising new ASPs and growing comfort with the off-lease model.

As far as used car trends, this recent Manheim index helps paint the picture:

While new car gross margins continue to move lower due to digital price transparency, auto dealers

have handled used car gross profits much better given their ability to source new cars from trade-ins

and other opaque channels. Pure online retailers such as Carvana, Vroom and Shift which also transact

in the used market, have grown members and revenue via easily used websites and expensive

marketing. However, those businesses have no tangible profit or cash generation strategy given the

inability to source vehicles cheaply (mostly at auction), higher logistics costs (pick-up and delivery via

truck) and no back end (parts and service) businesses.

Other semi-national public auto retailers like Lithia, Group 1, Sonic, Asbury and Penske are accelerating

‘omni-channel’ efforts of various types, including used auto, service & parts as well and financial and

insurance portals. Lithia is close to rolling out a national digital strategy after separating its financial

investment in Shift (and likely selling it into a SPAC). See my prior LAD write-up, where I recommended it

at $135 recently.

Due to Covid, the public retailers have enacted large cost cutting programs and most of these

management teams now recognize a structural drop in the opex required given the accelerated

transition to digital.

INVESTMENT CASE:

Investment case for AN is simple: While AN is the largest auto dealer, the stock has lagged peer

performance in our opinion due to some turnover but more importantly, management’s lack of

disclosure and long term capital allocation/digital strategy.

Unlike Autonation, peers such as Lithia, Group 1, Asbury and Sonic have provided exceptional mid

quarter and end of quarter updates, suggesting consensus estimates need to come up

significantly. Importantly, each of these other companies has rolled out some form of digital strategy

disclosure to investors via management presentation, investor meetings and conference calls. In the

meantime, it appears that Autonation has avoided any disclosure of results or strategy.

Peer underperformance: Interestingly, AN had been doing quite well relative to peers. However, this is

not true recently and we believe that’s an opportunity. If you look at AN’s performance relative to peer

Asbury (ABG), at one point this year going into the Covid crash, AN had outperformed ABG significantly.

That’s now completely reversed. Similarly, the same can be said about AN’s performance relative to

peer Sonic Automotive (SAH). AN had outperformed SAH by 80% YTD going to March, and has now given

it all back. It has also already de-rated relative to LAD (see prior write up). Having followed this industry

for a decade plus, this doesn’t make a lot of sense. These businesses are not so different to warrant such

a disconnect. We speculate that this is due to lack of disclosure from Autonation, not company specific

issues. All of these auto retailers above are dealing with the same Covid macro forces (unemployment,

work from home, etc.) not just Autonation.

SHAREHOLDER BASE:

AN has large share owners that include Eddie Lampert’s ESL holding company and Cascade (Bill Gates’

holding company). Between ESL and Cascade, these two shareholders own 32% of the company. Despite

these savvy shareholders, the company hasn’t kept up with its peers in recent years. Part of the reason,

perhaps, is that CEO Michael Jackson has been a consistent seller of shares in the open market, most

recently at $52.60 in November of 2019, per Bloomberg. Michael Jackson has been with Autonation for

close to 20 years and the only constant in the upper management team over the past 5 years. The

company used to be a large player in M&A and an aggressive share repurchaser, retiring over 70% of the

float over a 15-year period! However, in the past 5 years, repurchase has been sporadic, M&A has been

infrequent, while multiple low return or opaque investments have been made. Some of those

investments have been cancelled but investors still have no visible or coherent capital allocation

strategy or digital plan.

Autonation’s website doesn’t even have an investor presentation. It’s actually very strange.

HIDDEN ASSET VALUE:

The company has a national footprint and has expressed its ability to cover that geography with its

digital business but investors don’t know much more than that. The company owns somewhere

between 7mm-9mm shares in newly public Vroom (VRM), which has a $6bn market cap, or 10%-15% of

AN’s market cap and a purely financial investment at this point. Obviously, we don’t know their plan

with this investment but presumably it could be monetized at some point.

STOCK SETUP:

AN should be set up for excellent core results over the next few quarters with strong gross profits out of

new and used along with significantly lower opex. The company had cut 7k employees as of late April,

of which only 2k-3k likely will return as business accelerates. However, the company should be able to

run the business on $150-$200mm less SGA ($1.50-$2 per share) with better productivity, use of

IT/digital sales and service tools. As mentioned above, the company should be able to monetize its

Vroom stake as there is no strategic reason for it that we can figure out.

Based on our estimates, AN is trading under 10x 2020 PE and 7.5x our 2021 estimates and close to a

20% free cash flow yield dependent on level of maintenance capex. We believe AutoNation simply

needs to improve their disclosure and lay out its long term capital allocation and digital strategy. If

management doesn’t make this effort, we believe the team could put itself at risk of shareholder

activism or even a takeover by another public, private equity or a private retailer. Complete speculation

on our part but logically, these potential strategic investors could include Lithia (LAD). An

Autonation/Lithia deal would be a significantly accretive and strategic transaction or even a Berkshire

Hathaway, which is presently in this business and has a $10bn auto retailer business which includes the

Van Tuyl group.

Risk/reward: We see downside of $33-$35, (15% downside) at which point activists or takeover

speculation could happen as the stock would look too cheap in our estimation. On the upside, if AN can

clearly lay out its capital allocation and digital plan, we think there is no reason the stock couldn’t see

multiple expansion above 10x-12x PE or of $60 (50%+ upside).

MODEL/ESTIMATES:

I do not hold a position with the issuer such as employment, directorship, or consultancy.
I and/or others I advise hold a material investment in the issuer's securities.

Catalyst

1. POTENTIAL UPSIDE TO CONSENSUS ESTIMATES

2. BETTER DISCLOSURES FROM COMPANY

3. COULD BE AN ACTIVIST CANDIDATE/POTENTIAL M&A CANDIDATE

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			2020	2021
Price:	40.32	EPS	4.36	5.76
Shares Out. (in M):	89	P/E	9.24	7
Market Cap (in $M):	4	P/FCF	0	0
Net Debt (in $M):	2,362	EBIT	0	0
TEV (in $M):	5,930	TEV/EBIT	0	0