AutoNation Inc. led car dealerships in providing the best way to participate in the U.S. auto industry’s rebound from its bottom three years ago.
The BLOOMBERG RISKLESS RETURN RANKING shows AutoNation produced the highest risk-adjusted return among six U.S. dealer groups since September 2009, the year the industry began a climb from the weakest demand for new autos in almost three decades. Car retailers, which are more flexible than assembly lines when cutting costs, outperformed the 24-member Bloomberg Industries North American Auto Parts index and an index of 18 automakers that sell vehicles in the U.S.
Chief Executive Officer Mike Jackson has said retailers like his can be profitable in good and bad markets because they make money servicing old vehicles and selling to used-car buyers when demand for new autos slips. AutoNation reported its only quarterly loss in the past decade in 2008’s third quarter, when Lehman Brothers Holdings Inc.’s failure fueled a credit crunch that dramatically reduced consumers’ ability to borrow money to buy cars.
The crisis was “a litmus test, a moment of truth, and if you look at the performance of the automotive retailers during the crisis period, in relative terms it was outstanding,” Jackson, 63, said in a telephone interview from AutoNation’s headquarters in Fort Lauderdale, Florida. “The beauty of our business model is the foundation is service and parts. That covers over 90 percent of our fixed costs.”
AutoNation had a total return of 127 percent since September 2009, the first month after government incentives for new car buyers that had inflated demand in July and August of that year expired. While AutoNation had the fourth-best total return among dealership groups, it had the lowest volatility at 33, giving it the No. 1 rank by risk-adjusted return.
Standard & Poor’s boosted the company to investment-grade last year, and Moody’s Investors Service in November assigned a positive outlook on its rating, the highest speculative-grade level.
“We’re able to adjust our cost base very quickly to changes in the marketplace,” Jackson said. “The manufacturer and supplier business model has high fixed costs, is extremely cyclical and not very resilient.”
Group 1 Automotive Inc. in Houston had the second-best total return at 131 percent and a volatility of 46, giving it second place in the ranking. Lithia Motors Inc., best by total return with a gain of 164 percent, ranked third, dragged down by the highest volatility in the group, at 60.
AutoNation, Group 1, Lithia Motors, Asbury Automotive Group Inc., Penske Automotive Group Inc., and Sonic Automotive Inc. combined to post a 3.1 percent risk-adjusted return, topping parts suppliers at 2.2 percent and automakers at 1.05 percent. The ranking is based on a Bloomberg Industries index of automotive dealers and excludes used-car dealers America’s Car-Mart Inc., CarMax Inc. and Copart Inc., as well as AutoCanada Inc., which sells cars in Canada.
The risk-adjusted return is calculated by dividing total return by volatility, or the degree of daily price-swing variation, giving a measure of income per unit of risk. The returns aren’t annualized. Higher volatility means an asset’s price can swing dramatically in a short period of time, increasing the prospect for unexpected losses.
AutoNation benefited from a stable ownership, with Edward Lampert’s RBS Partners LP hedge fund owning almost 40 percent of the company. The 50-year-old billionaire also personally held 18.6 million shares, a 15 percent stake, as of June 30, according to data compiled by Bloomberg. Cascade Investment LLC, Bill Gates’s personal money management firm, and his Gates Foundation hold ownership stakes of 13 percent and 2 percent, respectively.
AutoNation, the second-largest U.S. stock holding of RBS, has delivered some of the best profits for Lampert, with annual gains of 31 percent since September of 2009. Sears Holding, RBS’s largest U.S. stock position, has languished at 2009 levels, gaining an annual 1.9 percent in the same period.
Asbury Automotive provided a risk-adjusted return of 2.7 percent since September 2009. Billionaire Michael Dell’s MSD Capital LP holds a 10.5 percent stake in Duluth, Georgia-based Asbury, according to data compiled by Bloomberg.
Michael Larson, chief investment officer of Cascade Investment in Kirkland, Washington, and Todd Fogarty, a spokesman for MSD Capital, declined to comment for this story. A spokesmen for Lampert didn’t return an e-mail seeking comment.
“I don’t think there are a lot people who really understand this industry, who understand what we have and just how good of a business this is,” Craig Monaghan, CEO of Duluth, Georgia-based Asbury Automotive, said in a telephone interview. “The richest guy in town is never the doctor or the lawyer. It’s the guy who owns the dealership. There’s a reason for that.”
U.S. auto sales are on pace to exceed 14 million this year for the industry’s best total since 2007, according to Autodata Corp. The new-car market is on track to grow for a third consecutive year.
The industry is rebounding after a plunge to 10.4 million light-vehicle sales in 2009, the worst year for the U.S. market since 1982. Annual deliveries averaged 16.8 million from 2000 to 2007, according to Autodata in Woodcliff Lake, New Jersey.
The increasing sales are being spread across a smaller U.S. auto-dealer footprint, according to Urban Science, a Detroit-based consulting firm.
General Motors Co. and Chrysler Group LLC pared their retail networks as part of their 2009 U.S. government-backed bankruptcies. The U.S. industry now has fewer than 30,000 dealer franchises, down from almost 50,000 in 1997, Urban Science said in an Aug. 14 report.
That means new-vehicle sales probably will climb to a record 805 per dealership in 2012 as demand recovers faster than estimated and carmakers keep the number of their retail outlets stable, according to the report.
“In that scenario, where I’ve leaned out my cost structure to the bone, I’d rather be a dealer” than a supplier or automaker, Kevin Tynan, an automotive analyst with Bloomberg Industries based in Princeton, New Jersey, said in a telephone interview. “As the industry starts to recover, the retailers’ cost structure, which was leaned to the bone in 2009 and 2010, is probably still lean relative to before the crash.”
Industrywide per-store dealership profit has almost tripled from 2008, according to the National Automobile Dealers Association, which represents 16,000 new-car dealers. The average U.S. auto dealer earned a pretax profit of $785,855 last year on revenue of $34.7 million, McLean, Virginia-based NADA said in its year-end report. Dealers’ average pretax profit was $279,685 in 2008.
Auto retailers’ labor costs are variable because their workers’ compensation typically is tied to commissions for every car they sell or repair, Bloomberg Industries’ Tynan said. Automakers and suppliers have a more difficult time keeping those costs contained because they need to maintain much of their work force to keep plants operational.
“As demand starts to come back, you have that lag where you have half the sales and back office people you had when we were at 16 million” annual vehicle sales, Tynan said. “You have this window of opportunity for expanded margins.”
The “foundation” of AutoNation is its parts and service business, Jackson said. The retailer focused on keeping fixed costs down through the industry sales decline and relied on gross profit from that line of business to offset 90 percent or more of those costs.
“When I wake up in the morning, I’m 91 percent happy before I leave the house,” Jackson told employees at an Atlanta town hall in August 2011. “I’m looking forward to the day that I wake up 100 percent happy. I’m going to sleep in.”
AutoNation’s gross margin in the parts and service business exceeded 43 percent in every quarter during 2010 and has exceeded 41 percent in each of the last five periods, Bloomberg data shows. That compares to as much as a 9.8 percent margin in its used-vehicle retail business and as much as 7.8 percent in new vehicles.
Asbury’s parts and service gross margin has averaged 55 percent in the last 10 quarters, the data show. The segment is the “real bread and butter” of Asbury’s business, said Monaghan, the CEO.
“It’s a business that just continues to perform in good times and bad,” he said. “I wouldn’t say it’s recession-proof, but it’s certainly very much recession-resilient.”
AutoNation closed at an all-time high of $42.45 on July 19, while Asbury climbed to a record $29.93 on Sept. 14. Penske Automotive, based in Bloomfield Hills, Michigan, reached its best close ever on Sept. 17, rising to $30.32.
“The dealer business model is a lot less cyclical than people think it is,” Matthew Nemer, an analyst at Wells Fargo Securities based in San Francisco, said in a telephone interview. “In a deep recession, you may not need to get your bumper fixed, but if there’s a mechanical problem with the car and you use it to get to work, you need to get it fixed. That profit line is incredibly stable.”
The share performance by the companies is a stark turnaround since the economic crisis four years ago. AutoNation fell 37 percent in 2008 and reached a low of $4.21 in October of that year. Asbury plunged 70 percent and slipped to as low as $2 the same month that year. Penske declined 56 percent in 2008 and dropped to $4.84 in March 2009.
“During the recession, the market basically priced all these companies as if they were going bankrupt,” Wells Fargo’s Nemer said. “The public dealers haven’t been around all that long and they’d never been through a deep recession. There was a little bit of fear of the unknown.”
Nemer, whose family owns a chain of car dealerships, said auto retailers’ stock-market outperformance compared with carmakers and suppliers may reflect a “bounce” from deeper bottoms, rather than their prospects in a recovery. Carmakers may be better to own in that scenario, he said.
“As the capacity starts to fill up, for the manufacturers where you have fixed capacity and you start to fill that capacity and cover your fixed costs, that’s where you get sort of explosive earnings growth,” he said.
Monaghan said auto retailers still trade at relatively lower valuations compared to most retailers. Some investors discount their shares because car manufacturers need to give permission for adding additional stores.
“Some people look at our model and say ‘well, they can’t grow because the manufacturer controls their ability to open a greenfield site,” he said. Those investors are overlooking the fact that automakers’ restrictions also shield retailers from added competitors entering their area.
“You have a protected business that produces a very nice cash flow,” he said. “They’ve missed what is really a very attractive investment here. It’s very consistent, reasonably predictable business that throws off cash.”