After Sales Strength And AN Finance Expansion Will Support Stable Long Term Earnings Outlook

Catalysts

About AutoNation

AutoNation operates a large-scale, multi-brand automotive retail platform focused on new and used vehicle sales, finance and insurance products, and high-margin after-sales services.

What are the underlying business or industry changes driving this perspective?

• Although AN Finance is scaling quickly with improving credit quality and rising nonrecourse funding, the continued normalization of delinquencies toward the 3% range and any macro weakening in consumer credit could cap portfolio growth and compress risk adjusted returns, limiting upside to earnings.
• Despite record After-Sales performance and expanding technician capacity, the growing mix of technologically complex hybrids and BEVs may drive higher tooling, training and warranty related costs, which could erode some of the recent 100 basis point margin expansion and temper future net margin growth.
• While demand for electrified and higher priced vehicles has supported revenue, sustained pressure on BEV and domestic ICE unit profitability combined with OEM decontenting and reduced incentive support may structurally reset new vehicle gross profit per unit lower, constraining operating margin leverage.
• Although used vehicle volumes are outpacing the market, management’s decision to hold elevated inventory in a tight but volatile supply environment increases depreciation risk and exposure to wholesale price reversals, which could weigh on used gross profit and overall gross margin if demand softens.
• While the industry outlook for light vehicle sales is currently reasonable, tougher year over year comparisons, potential tariff and supply chain adjustments, and a more muted luxury demand environment could slow top line growth and limit further adjusted EPS expansion despite disciplined SG&A control.

Assumptions

This narrative explores a more pessimistic perspective on AutoNation compared to the consensus, based on a Fair Value that aligns with the bearish cohort of analysts. How have these above catalysts been quantified?

• The bearish analysts are assuming AutoNation's revenue will grow by 2.3% annually over the next 3 years.
• The bearish analysts assume that profit margins will increase from 2.4% today to 2.9% in 3 years time.
• The bearish analysts expect earnings to reach $876.2 million (and earnings per share of $25.29) by about December 2028, up from $663.1 million today. The analysts are largely in agreement about this estimate.
• In order for the above numbers to justify the price target of the more bearish analyst cohort, the company would need to trade at a PE ratio of 9.5x on those 2028 earnings, down from 11.6x today. This future PE is lower than the current PE for the US Specialty Retail industry at 20.2x.
• The bearish analysts expect the number of shares outstanding to decline by 6.62% per year for the next 3 years.
• To value all of this in today's terms, we will use a discount rate of 11.99%, as per the Simply Wall St company report.

Risks

What could happen that would invalidate this narrative?

• Persistent strength in high margin After Sales, supported by technician headcount growth and higher value repair orders, could continue to expand gross margins and operating income. This could lead to structurally higher earnings and support a higher share price over time by lifting net margins and cash generation.
• Rapid scaling of AN Finance with improving credit quality, higher nonrecourse funding and attractive returns on equity could turn the captive into a durable profit engine. This may accelerate earnings growth and boost valuation multiples through stronger net interest income and overall earnings.
• Ongoing growth in Customer Financial Services with record per-vehicle profitability, strong attachment of extended service contracts and higher finance penetration may keep driving double digit gross profit gains. This would lift consolidated gross profit and EPS faster than expected.
• Effective used vehicle sourcing, willingness to hold elevated inventories to pursue higher volumes and strong performance in higher priced used segments could translate into sustained revenue growth above the industry. This may offset margin pressure and push overall earnings higher.
• Disciplined SG&A control within the targeted 66 to 67% of gross profit range, combined with robust free cash flow conversion and continued share repurchases, may enhance per share earnings growth and shareholder returns. This could support share price appreciation through higher EPS and free cash flow per share.

Valuation

How have all the factors above been brought together to estimate a fair value?

• The assumed bearish price target for AutoNation is $200.0, which represents up to two standard deviations below the consensus price target of $238.1. This valuation is based on what can be assumed as the expectations of AutoNation's future earnings growth, profit margins and other risk factors from analysts on the more bearish end of the spectrum.
  
• However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $300.0, and the most bearish reporting a price target of just $200.0.
  
• In order for you to agree with the more bearish analyst cohort, you'd need to believe that by 2028, revenues will be $29.9 billion, earnings will come to $876.2 million, and it would be trading on a PE ratio of 9.5x, assuming you use a discount rate of 12.0%.
  
• Given the current share price of $210.07, the analyst price target of $200.0 is 5.0% lower. The relatively low difference between the current share price and the analyst consensus price target indicates that they believe on average, the company is fairly priced.
  
• We always encourage you to reach your own conclusions though. So sense check these analyst numbers against your own assumptions and expectations based on your understanding of the business and what you believe is probable.