GROUP 1 AUTOMOTIVE INC GPI
July 13, 2016 - 6:06pm EST by
nantembo629
2016 2017
Price: 54.00 EPS 7.25 8
Shares Out. (in M): 22 P/E 7.4 6.8
Market Cap (in $M): 1,160 P/FCF 9.3 9
Net Debt (in $M): 1,270 EBIT 370 390
TEV ($): 2,430 TEV/EBIT 6.5 6.25

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Description

 
We believe Group 1 Automotive (GPI) represents a very attractive risk/reward at current levels. Auto
dealerships are high quality businesses that have enjoyed both the resurgence in new auto sales and
industry consolidation post the financial crisis. However, multiple fears (i.e. peak in auto sales, growth
of Uber/ride-sharing, Tesla, driverless cars, etc.) have led to an investor exodus of the group. GPI, in
particular, has been hit due to these fears but also due to its geographic exposure. However, we think
GPI has been over-penalized and see the risk/reward at current valuation as extremely compelling.
PGTenny provided a great write-up in July 2013 on the auto dealers with an in-depth overview of
industry dynamics. We would point you to that and the follow-up discussion for background. It was
written up at an earlier part of the cycle but most of it is still very relevant to todays opportunity. Since
that write-up, sentiment on the stock/industry vastly improved until the space became very crowded
(GPI stock almost hit $100 a year ago). In the past year, sentiment has completely turned to the hatred
observed today. There are clearly risks but we think this is more than reflected in valuation.
 
Company Overview:
 
GPI is the 3rd largest car dealership in the US with smaller divisions in the UK (less than 10% of GP) and
Brazil (less than 5% of GP). The company is well run by a management team with a history of good
execution and capital allocation. The notable exception to this was when they purchased a large group
of Brazilian auto dealerships in 2013. The purchase occurred near the peak of the Brazilian auto market
and, so far, the acquisition has massively disappointed.
 
The geographic exposure of GPI has been a source of concern for investors. Clearly Brazil has been a
disaster and the companys UK exposure has not been looked upon favorably due to recent events.
However, we see the Brazilian exposure as somewhat of a very low-priced option and think UK macro
fears are overblown. ~60% of the companys US new vehicle sales are in the energy-producing states of
Texas and Oklahoma. Oil prices are well off the lows but obviously another move down would be a
headwind. Once again, this fear is well-know and, we think, more than priced in.
 
Once again, please review PGTennys write-up for more detail on the business model but the most
important takeaways are the smaller than expected profits attributable to new auto sales and the
tailwind for growth in Parts & Services. New vehicle sales represent ~56% of revenue (and the majority
of investors fears), yet it only represents ~20% of gross profit. We think this is still underestimated by
investors. Parts & Services only represent ~11% of revenue but provide ~42% of the companys gross
profit. The Parts & Services tailwind discussed is also still in effect and should provide growth of mid-to-
high single digits for the foreseeable future with very high incremental margins. Earnings would clearly
be hit from a pullback in auto sales but not as much as most investors would assume.
 
Valuation
 
On our estimates, GPI should earn ~$7.25 of EPS in 2016 and ~$8 of EPS in 2017. Auto dealers, including
GPI, have historically traded between 10-14x earnings. Todays trading multiples of 7.5x 2016 EPS and
6.75x 2017 EPS clearly show the negative sentiment and large estimate cuts are already being priced in
by the investment community. We dont expect much further growth in SAAR but also think that a large
pullback would only occur in conjunction with a recession.
 
While we think auto dealerships are higher quality businesses than they are given credit for (although
admittedly cyclical), we utilize the bottom end of the historic valuation range due to negative sentiment
towards the auto cycle, geographic exposure and perceived longer term risks. We think the stock is
worth ~$75 today (~40% upside with the current 1.7% div yield).
 
Another consideration is that in 2014 Buffett purchased a car dealership and has publicly stated that he
would be looking to purchase more of them. We would not be surprised to see him take advantage of
the de-rating in industry valuations since his original dealership purchase.
 
Major Risks
 
The main risks to the thesis include:
 
- Recession 
- Uber/other ride-sharing services lowering demand for new cars going forward
- Disintermediation of auto dealers
- Capital allocation is a risk and management could look to make a large acquisition for which they may
  overpay. Management has been prudent on acquisitions since the large Brazilian one while also
  buying back stock.
 
 
 

 

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

- Earnings coming in better than low expectations

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