Asbury Automotove ABG
April 24, 2008 - 6:05am EST by
bedrock346
2008 2009
Price: 14.05 EPS
Shares Out. (in M): 0 P/E
Market Cap (in $M): 448 P/FCF
Net Debt (in $M): 0 EBIT 0 0
TEV ($): 0 TEV/EBIT

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Description

So consumer, retail and automotive exposure may not quite be what most people are looking to add to their current portfolio but Asbury Automotive (ABG) is a terrific value investment.  ABG which owns auto dealers, has the potential to more than double and pays a 6.4% yield while you wait.  It has a market capitalization of approximately $450m (32 million shares x $14), long-term debt of $475m and cash of roughly $50m for a TEV of $875m.  The stock currently trades at just 7.5x consensus earnings estimates.  It arguably trades at well below 6x EPS in a normalized environment.  They key to the value of ABG is the resiliency of its business model.  Even in a recession, and I assume we are in one, ABG will generate decent earnings, pay its dividend and increase its long-term earnings potential through attractive acquisitions.   

 

Business Model    

 

Years ago the Company made a strategic decision to focus on foreign and luxury brands.  This was a brilliant move that explains a great deal of why ABG’s earnings can hold up even in a weak market.  Over 80% of ABG’s new car sales are luxury or mid-line imports.  Investors in this space closely track SAAR (Seasonally Adjusted Automotive Retail sales) and freak out when they decline.  But SAAR is a very high level number and does not say anything about market share.  The domestic manufacturers have driven a great deal of this decline.  During the first quarter, for example, Chrysler sales declined 15.9% while Honda (ABG’s largest new car brand at approximately 30% of sales) declined only .4%.  The Company also has a balanced business model that sells both new and used cars and provides service and financing.

 

The Company’s strong parts & service and finance operations make it more resistant to economic downturns.  While 85% revenues are generated by car sales, parts and services and financing generate almost 60% of gross margin.  In 2007, the revenue and gross margin contribution were:

 

 

Revenue

% of Total

Gross Profit

% of Total

Gross Margin

New Car

$3,223

56%

$237

27%

8%

Used Car

1,114

20%

127

14%

11%

Fleet

512

9%

0

0%

0%

Parts

703

12%

363

41%

52%

Finance

162

3%

162

18%

100%

Total

$5,713

100%

$889

100%

16%

 

Parts & services are not cyclical like car sales.  If you need your car fixed, you get it fixed.  If anything, consumers will rely more on servicing to defer having to buy another car during tough times.  The Company anticipated growing this area of the business during 2008.  While financing volume is dependent on car sales, it is a very lucrative business for ABG with no risk.  ABG simply collects a fee from third party providers- the Company has absolutely no balance sheet risk associated with its financing revenue.  By selling both new and used cars, the Company also makes itself less volatile during tough times.  Used car sales have typically shown less cyclicality than new cars during economic stress.  But if manufacturers become aggressive with incentives in response to the downturn (making new cars relatively more attractive than used cars), the benefit to new car sales will help offset the loss in used car sales.

 

While SAAR will no doubt decline this year (though the brands which ABG owns will fare relatively better), ABG should earn $1.40-$1.50 even in a 14m SAAR, which is a deep recession.  How low could SAAR go?  During the consumer recession in 1990 SAAR fell to 11.3m.   Since that time the US population has increased from approximately 250m to 300m (or 20%).  So growing recession SAAR by population gets a trough value of 13.6m.  But the average car ownership per capital has also increased- families in the US simply own mores vehicles.  If you take this into account, a SAAR of 14m seems appropriate number for a deep consumer recession scenario.  To be clear, SAAR is not currently at this level and manufactures are projecting total production of a little over 15m (approximately the level in the first quarter this year).   Last year SAAR was 16.3m.  The table below shows historical SAAR for prospective:

 

Year

SAAR

2007

16.3

2006

16.6

2005

17.0

2004

17.7

2003

17.5

2002

17.9

2001

16.2

2000

15.7

1999

17.9

1998

17.0

1997

16.1

1996

14.8

1995

15.9

1994

15.2

1993

14.7

1992

13.5

1991

11.3

1990

12.7

1989

13.3

Source: Bloomberg

 

In our model, we assume continued market share gains for luxury and foreign (it is hard to imagine this not being the case) but sales declining steeply in every area (this could be conservative if domestic sales really implode).  We assume sales compensation is variable (commission determines much of these numbers) and that the Company will cut certain S, G & A areas such as advertising and outside services with a slight decrease in personal, with other segments growing with inflation (rent, utilities, etc.).  Financing revenues decline with fewer cars sold while parts & services remain steady.  Based on these assumptions, we get $1.47 in EPS at a 14m SAAR and $1.82 at a 15m SAAR.  These numbers seem consistent with conversations we have had with the Company as well as other analysts.  It should be noted that the Company will save money on its floor plan debt this year (this is the debt provided by the manufacturers to finance inventory, it is generally not included in long-term debt but the interest cost is taken out of EBITDA) as much of it is floating rate.  So the interest rate decline has helped ABG and if continued economic weakness necessitates the fed keeping rates low, ABG will benefit.

 

So on trough earnings, the Company trades at less than 10x EPS.  The stock is cheap in an almost worst case scenario.  Even taking a recession as given, the Company may still earn more than $1.50 .  Management is currently guiding to $1.80 to $2.00.  While we think the low end maybe more likely based on current trends, that is still a very nice earnings number.     

 

Dividends

 

The Company’s dividend is safe even in a deep recession that lasts through 2009.  ABG currently pays a $.90 dividend for a yield of approximately 6.4%.  Under its bond indentures, the Company can pay approximately 50% its earnings in dividends.  However, it also has a $20m carve out for dividends and share repurchases, which increases what it can pay out in dividends.  The Company has approximately 32m shares outstanding.  So if even if earns $1.50 for 2 years, the basket will enable it make up the difference and keep its dividend.  That’s a nice yield while you wait for the story to play out.

 

Catalysts

 

The stock is priced for a recession.  So the bar is set very low.  It is hard to see much downside from here (perhaps back to its 52 week low of just under $12) and the upside is considerable.  The stock traded at $30 in April 2007.  Even then it was not expensive.   As investors look for stocks that anticipate an economic recovery, ABG should bounce as long as its earnings are not disastrous.  While its not a specific event catalyst, I don’t think it will take much to get ABG moving. 

 

Risks

 

The most obvious risk is a macro economic melt down on a scale beyond what I have used in my model as a recession.  While possible, I think it is unlikely.  Other risks include:

 

§         Automotive finance scarce.  ABG did have weaker earnings in the second half of 2007 as finance for subprime buyers for its used cars became less available.  While this is an issue it primarily impacts used car sales and only a minority of its buyers are sub prime.  Our due diligence indicates that financing for cars remains reasonably stable as the loans are considered safer than most (they are collateralized, the collateral is easily sold and most people are very reluctant to default on a car loan as they often need their car to get to work).  

 

§         Florida exposure.  ABG does have considerable exposure to the Florida market and this area of the country is more economically challenged (though ABG’s exposure is mostly in the northern part of the state, which is doing relatively better than the southern area).  This is a known risk and the Company has baked it into its guidance but clearly the economic conditions could always be worse than predicted.  On the positive side of Florida, the state is growing significantly in population and the number of luxury and foreign dealers is basically fixed.  

 

§         1Q earnings could disappoint.  It is a cyclically weak quarter and indications are the macro environment remains rough.  So maybe able to enter a lower prices in the not too distant future. 

 

Conclusion

 

In normalized conditions, ABG can earn over $2 per share (it earned $2.09 in 2007).  Over time, its earnings potential has grown both through organic growth and accretive acquisitions.  Management of ABG is very strong and they are extremely well regarded within the industry.  Its dealerships are very valuable.  They are great brands (Honda, Toyota, BMW).  Each dealership is a local monopoly- by legal agreement, another competitor will not emerge.  

 

What is the stock worth in the long-run?  Penske Automotive (PAG) has indicated in meeting that it looked at buying ABG for north of $20 (so 40% or more upside from the current price).  People I have spoken with in the industry believe the break-up value (simply selling off all its dealerships) of the Company, even in this distressed environment, is also north of $20.   I think ABG is worth closer to $40 in the long-term.  The Company’s real earnings power is in the $2.50 and higher range.  At a 15x multiple you get a stock price of $37.50.  That is great return even if it takes 2-3 years and along the way you are getting a great dividend stream.      

  

Catalyst

The real catalyst is earning its way through this period and maintaining the dividend. At current levels, you are paid to wait with a over 6% yield. I believe the market is expecting earnings closer to $1.5, anything better would probably be a positive for the stock. A buyout is possible but not what I am counting on.
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    Description

    So consumer, retail and automotive exposure may not quite be what most people are looking to add to their current portfolio but Asbury Automotive (ABG) is a terrific value investment.  ABG which owns auto dealers, has the potential to more than double and pays a 6.4% yield while you wait.  It has a market capitalization of approximately $450m (32 million shares x $14), long-term debt of $475m and cash of roughly $50m for a TEV of $875m.  The stock currently trades at just 7.5x consensus earnings estimates.  It arguably trades at well below 6x EPS in a normalized environment.  They key to the value of ABG is the resiliency of its business model.  Even in a recession, and I assume we are in one, ABG will generate decent earnings, pay its dividend and increase its long-term earnings potential through attractive acquisitions.   

     

    Business Model    

     

    Years ago the Company made a strategic decision to focus on foreign and luxury brands.  This was a brilliant move that explains a great deal of why ABG’s earnings can hold up even in a weak market.  Over 80% of ABG’s new car sales are luxury or mid-line imports.  Investors in this space closely track SAAR (Seasonally Adjusted Automotive Retail sales) and freak out when they decline.  But SAAR is a very high level number and does not say anything about market share.  The domestic manufacturers have driven a great deal of this decline.  During the first quarter, for example, Chrysler sales declined 15.9% while Honda (ABG’s largest new car brand at approximately 30% of sales) declined only .4%.  The Company also has a balanced business model that sells both new and used cars and provides service and financing.

     

    The Company’s strong parts & service and finance operations make it more resistant to economic downturns.  While 85% revenues are generated by car sales, parts and services and financing generate almost 60% of gross margin.  In 2007, the revenue and gross margin contribution were:

     

     

    Revenue

    % of Total

    Gross Profit

    % of Total

    Gross Margin

    New Car

    $3,223

    56%

    $237

    27%

    8%

    Used Car

    1,114

    20%

    127

    14%

    11%

    Fleet

    512

    9%

    0

    0%

    0%

    Parts

    703

    12%

    363

    41%

    52%

    Finance

    162

    3%

    162

    18%

    100%

    Total

    $5,713

    100%

    $889

    100%

    16%

     

    Parts & services are not cyclical like car sales.  If you need your car fixed, you get it fixed.  If anything, consumers will rely more on servicing to defer having to buy another car during tough times.  The Company anticipated growing this area of the business during 2008.  While financing volume is dependent on car sales, it is a very lucrative business for ABG with no risk.  ABG simply collects a fee from third party providers- the Company has absolutely no balance sheet risk associated with its financing revenue.  By selling both new and used cars, the Company also makes itself less volatile during tough times.  Used car sales have typically shown less cyclicality than new cars during economic stress.  But if manufacturers become aggressive with incentives in response to the downturn (making new cars relatively more attractive than used cars), the benefit to new car sales will help offset the loss in used car sales.

     

    While SAAR will no doubt decline this year (though the brands which ABG owns will fare relatively better), ABG should earn $1.40-$1.50 even in a 14m SAAR, which is a deep recession.  How low could SAAR go?  During the consumer recession in 1990 SAAR fell to 11.3m.   Since that time the US population has increased from approximately 250m to 300m (or 20%).  So growing recession SAAR by population gets a trough value of 13.6m.  But the average car ownership per capital has also increased- families in the US simply own mores vehicles.  If you take this into account, a SAAR of 14m seems appropriate number for a deep consumer recession scenario.  To be clear, SAAR is not currently at this level and manufactures are projecting total production of a little over 15m (approximately the level in the first quarter this year).   Last year SAAR was 16.3m.  The table below shows historical SAAR for prospective:

     

    Year

    SAAR

    2007

    16.3

    2006

    16.6

    2005

    17.0

    2004

    17.7

    2003

    17.5

    2002

    17.9

    2001

    16.2

    2000

    15.7

    1999

    17.9

    1998

    17.0

    1997

    16.1

    1996

    14.8

    1995

    15.9

    1994

    15.2

    1993

    14.7

    1992

    13.5

    1991

    11.3

    1990

    12.7

    1989

    13.3

    Source: Bloomberg

     

    In our model, we assume continued market share gains for luxury and foreign (it is hard to imagine this not being the case) but sales declining steeply in every area (this could be conservative if domestic sales really implode).  We assume sales compensation is variable (commission determines much of these numbers) and that the Company will cut certain S, G & A areas such as advertising and outside services with a slight decrease in personal, with other segments growing with inflation (rent, utilities, etc.).  Financing revenues decline with fewer cars sold while parts & services remain steady.  Based on these assumptions, we get $1.47 in EPS at a 14m SAAR and $1.82 at a 15m SAAR.  These numbers seem consistent with conversations we have had with the Company as well as other analysts.  It should be noted that the Company will save money on its floor plan debt this year (this is the debt provided by the manufacturers to finance inventory, it is generally not included in long-term debt but the interest cost is taken out of EBITDA) as much of it is floating rate.  So the interest rate decline has helped ABG and if continued economic weakness necessitates the fed keeping rates low, ABG will benefit.

     

    So on trough earnings, the Company trades at less than 10x EPS.  The stock is cheap in an almost worst case scenario.  Even taking a recession as given, the Company may still earn more than $1.50 .  Management is currently guiding to $1.80 to $2.00.  While we think the low end maybe more likely based on current trends, that is still a very nice earnings number.     

     

    Dividends

     

    The Company’s dividend is safe even in a deep recession that lasts through 2009.  ABG currently pays a $.90 dividend for a yield of approximately 6.4%.  Under its bond indentures, the Company can pay approximately 50% its earnings in dividends.  However, it also has a $20m carve out for dividends and share repurchases, which increases what it can pay out in dividends.  The Company has approximately 32m shares outstanding.  So if even if earns $1.50 for 2 years, the basket will enable it make up the difference and keep its dividend.  That’s a nice yield while you wait for the story to play out.

     

    Catalysts

     

    The stock is priced for a recession.  So the bar is set very low.  It is hard to see much downside from here (perhaps back to its 52 week low of just under $12) and the upside is considerable.  The stock traded at $30 in April 2007.  Even then it was not expensive.   As investors look for stocks that anticipate an economic recovery, ABG should bounce as long as its earnings are not disastrous.  While its not a specific event catalyst, I don’t think it will take much to get ABG moving. 

     

    Risks

     

    The most obvious risk is a macro economic melt down on a scale beyond what I have used in my model as a recession.  While possible, I think it is unlikely.  Other risks include:

     

    §         Automotive finance scarce.  ABG did have weaker earnings in the second half of 2007 as finance for subprime buyers for its used cars became less available.  While this is an issue it primarily impacts used car sales and only a minority of its buyers are sub prime.  Our due diligence indicates that financing for cars remains reasonably stable as the loans are considered safer than most (they are collateralized, the collateral is easily sold and most people are very reluctant to default on a car loan as they often need their car to get to work).  

     

    §         Florida exposure.  ABG does have considerable exposure to the Florida market and this area of the country is more economically challenged (though ABG’s exposure is mostly in the northern part of the state, which is doing relatively better than the southern area).  This is a known risk and the Company has baked it into its guidance but clearly the economic conditions could always be worse than predicted.  On the positive side of Florida, the state is growing significantly in population and the number of luxury and foreign dealers is basically fixed.  

     

    §         1Q earnings could disappoint.  It is a cyclically weak quarter and indications are the macro environment remains rough.  So maybe able to enter a lower prices in the not too distant future. 

     

    Conclusion

     

    In normalized conditions, ABG can earn over $2 per share (it earned $2.09 in 2007).  Over time, its earnings potential has grown both through organic growth and accretive acquisitions.  Management of ABG is very strong and they are extremely well regarded within the industry.  Its dealerships are very valuable.  They are great brands (Honda, Toyota, BMW).  Each dealership is a local monopoly- by legal agreement, another competitor will not emerge.  

     

    What is the stock worth in the long-run?  Penske Automotive (PAG) has indicated in meeting that it looked at buying ABG for north of $20 (so 40% or more upside from the current price).  People I have spoken with in the industry believe the break-up value (simply selling off all its dealerships) of the Company, even in this distressed environment, is also north of $20.   I think ABG is worth closer to $40 in the long-term.  The Company’s real earnings power is in the $2.50 and higher range.  At a 15x multiple you get a stock price of $37.50.  That is great return even if it takes 2-3 years and along the way you are getting a great dividend stream.      

      

    Catalyst

    The real catalyst is earning its way through this period and maintaining the dividend. At current levels, you are paid to wait with a over 6% yield. I believe the market is expecting earnings closer to $1.5, anything better would probably be a positive for the stock. A buyout is possible but not what I am counting on.

    Messages


    SubjectPrivate market value
    Entry04/24/2008 05:47 PM
    Membergrant387
    Some questions.

    What have you found to be private market value of dealership groups on a price/sales basis?

    Any balance sheet issues make a P/S multiple not relevant at ABG?

    What has been the structure of their rollups? Do they own the dirt? Have they done sale/leasebacks?

    Any relative value comments in regards to SAH, AN, etc.?

    Nice succinct writeup - thanks for posting it.

    SubjectRE: Private market value
    Entry04/25/2008 03:23 PM
    Memberbedrock346
    Some Answers:



    1) They target acquiring $200m in revenue per year but last year acquired $350m in revenue. Price / sales varies based upon the brands and business mix of the dealers they are acquiring (see answer #2). Management analyzes acquisitions more on an EBITDA and EBIT multiple basis.

    2) I don’t really like using the price to sales multiple for this situation. More for income statement reasons than balance sheet reasons. They generate lot revenues from car sales but most of the margins from servicing and financing. They also have big fleet sales that have no contribution. So not all sales are equal. I prefer P/E and TEV / EBITDA. I focused on P/E in the write-up because that is the ratio analysts have tended to focus on so it really trades on that.

    3) They own the dirt but typically do sale leasebacks. They use sale lease backs a lot to reduce capex and acquisition cash costs.

    4) The whole sector trades at cheap multiple. But I think you really want to own the companies with high foreign & luxury exposure. They will be the relative winners. So prefer ABG to SAH and AN. PAG also has a great brand mix but it is much more expensive than ABG on a multiple basis (13x v. 8x est p/e). So I much prefer ABG to PAG on a relative valuation basis.


    Subjectbuyout
    Entry04/25/2008 07:57 PM
    Memberarmand440
    thank you for a good write-up. you list a buyout as a possible catalyst... who do you think are likely buyers? i imagine that ripplewood shopped the company before they sold their block, and it is my understanding that the OEMs vetoed an acquisition by Penske and Autonation.

    SubjectRE: buyout
    Entry04/25/2008 09:17 PM
    Memberbedrock346
    OEMs made it more difficult, not impossoble. I think I said a buyout was unlikely, but Penske has admitted bidding on the company around $20. I think this is an earnings validation play with a nice current yield while you wait.

    SubjectQuestions
    Entry04/26/2008 11:38 AM
    Memberdavid101
    Bedrock,

    Kind of a contrarian idea. Have some questions:

    1. Parts & Service - There are plenty of cheaper substitutes to having your car serviced at a dealership. What would keep customers from doing that in a recession?

    2. Financing - Do you have any sense as to the current OEM financing landscape? Since 2/3 of their sales are financed, what happens in this arena can influence car sales. As I understand it, ABG assumes no liability on the loans and just collects an origination fee. But if the ultimate lender is having problems securitizing auto loans, that could have a trickle down effect on the types of lending available.

    Thanks.

    David

    SubjectResponse to David
    Entry04/28/2008 09:43 AM
    Memberbedrock346
    1) A lot of the servicing of the car has to be done at a factory authorized dealer (especially true for leases). That creates a stickier customer. I think parts and service down trading is more an issue for used car dealerships.

    2) The company maintains that to date customer financing has not been a problem. Also rememnber, with the vast majority of their brands foreign, they are in far better shape. That said a continuing meltdown of the financial sector can't be positive though not necessarily a disaster.

    SubjectBarrons
    Entry04/28/2008 09:45 AM
    Memberbedrock346
    I just wanted to point out that there was a very positive article in Barrons over the weekend, which may account for some of the stock's strength today.

    SubjectCurrent perspective
    Entry11/11/2008 11:13 AM
    Membermaggie1002
    Bedrock, given the situation confronting the OEMs, the intensifying woes for the economy/credit (all well-documented obviously), suspension of the dividend, current stock price, wonder if you can update us with your current perspective. Many thanks in advance.
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