Navigating Challenges And Embracing Opportunities In Automotive Retail For Sustained Growth

Key Takeaways

• Expansion in used vehicle sales and service segment improvements suggest potential for increased revenue and margins.
  
• Strategic focus on AutoNation Finance and efficient capital allocation indicates long-term value creation and positive financial health.
  
• Operational risks, shifting consumer preferences, and intense competition pose challenges to AutoNation's sales, profitability, and market position.

Catalysts

Through its subsidiaries, operates as an automotive retailer in the United States.

• Recovery from the CDK system outage, with operational impacts now behind the company, suggests a return to normal business processes and potential recovery in productivity and revenue.
  
• Expansion in the company’s AutoNation USA footprint and a focus on used vehicles, including an expected return to normal levels of used car inventory by the second half of August, could drive revenue and margins in the used vehicle segment.
  
• The increase in Customer Financial Services (CFS) profitability through the scaling of AutoNation Finance, representing a shift to a more profitable model, suggests potential long-term value creation and impact on net income.
  
• Growth in after-sales services with a 10% growth through May and initiatives for technician development and retention indicate a positive impact on revenue and margins in the service segment.
  
• Strategic capital allocation, including share repurchases and careful CapEx spending, aiming for efficient capital deployment to enhance shareholder value, suggests a positive effect on earnings per share and overall financial health.

Assumptions

• Analysts are assuming AutoNation's revenue will grow by 5.2% annually over the next 3 years.
• Analysts are assuming AutoNation's profit margins will remain the same at 2.9% over the next 3 years.
• Analysts expect earnings to reach $885.9 million (and earnings per share of $24.24) by about September 2027, up from $780.2 million today.
• In order for the above numbers to justify the analysts price target, the company would need to trade at a PE ratio of 8.2x on those 2027 earnings, which is the same as it is today today. This future PE is lower than the current PE for the US Specialty Retail industry at 14.3x.
• Analysts expect the number of shares outstanding to decline by 9.92% per year for the next 3 years.
• To value all of this in today's dollars, we will use a discount rate of 9.71%, as per the Simply Wall St company report.

Risks

• Dependency on single IT systems and vendors (e.g., CDK outage) poses a significant operational risk that can disrupt critical business processes across sales, after-sales services, and inventory management, leading to direct financial losses, reduced revenue, and impacted margins.
  
• Rising vehicle prices and interest rates can challenge consumer affordability, potentially reducing demand for new and used cars, which may negatively affect sales volumes and profit margins.
  
• A shift towards lower-priced used vehicles can dilute the company’s profitability and average selling prices (ASPs), potentially leading to decreased gross profit margins in the used vehicle segment.
  
• Changes in consumer preferences towards electric vehicles (EVs) might require AutoNation to adapt its inventory and sales strategies, which could impact profitability and the cost structure, given different margin profiles compared to traditional internal combustion engine vehicles.
  
• Competition in the automotive retail and services sector is escalating, including from online platforms, which could pressure sales volumes, profit margins, and market share if AutoNation does not effectively differentiate its service offerings and customer experience.

Valuation

• The analysts have a consensus price target of $190.3 for AutoNation based on their expectations of its future earnings growth, profit margins and other risk factors. However, there is a degree of disagreement amongst analysts, with the most bullish reporting a price target of $220.0, and the most bearish reporting a price target of just $145.0.
• In order for you to agree with the analyst's consensus, you'd need to believe that by 2027, revenues will be $31.0 billion, earnings will come to $885.9 million, and it would be trading on a PE ratio of 8.2x, assuming you use a discount rate of 9.7%.
• Given the current share price of $161.53, the analyst's price target of $190.3 is 15.1% higher.
• 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.