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Value Investors Buying Heavily into Auto Retailing

December 09, 2007 | About:
10qk

Peter Lindmark

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CarMax (KMX) has always been a compelling growth story. Tom Gayner, the Chief Investment Officer of Markel Corporation has owned CarMax’s stock for several years. When Berkshire Hathaway’s Lou Simpson purchased CarMax in the third quarter, my interest was naturally piqued. At first glance CarMax stock looks expensive. However, there is a long runway of growth with approximately 45,000 independent used vehicle dealers while CarMax has only 86 used car superstores. Wal-Mart (WMT) has operating margins of 6.5% while CarMax’s operating margins were 4.9% in 2006. As they grow they can leverage their fixed costs, i.e. they can buy advertising as well as materials for stores nationwide, similar to the way one goes to Costco to buy in bulk to receive a discount.

CarMax looks interesting, but value investors are cheap and want to pay a much lower price for a car retailer, after all it takes a lot of working capital to fill up those superstores huge lots with inventory. Now there is another well known value investor Eddie Lampert, who has been scooping up shares of AutoNation since the end of October. Mr. Lampert knows the auto industry well. He has been an AutoNation (AN) shareholder since 2001, and presently owns over 30% of the company. He also has held a substantial stake in AutoZone (NYSE: AZO), an auto parts retailer since 2001, and presently owns 33% of AutoZone, which gives him further insight into the auto industry.

Here is a financial comparison of the two companies:

AutoNation (AN: $16.36)

CarMax (KMX: $22.20)

EV/EBITDA

8.2

12.7

EV/Revenue

0.37

0.64

Forward P/E

10.23

19.65

Trailing P/E

11.22

22.38

Price/Book

0.87

3.56

AutoNation’s business has four main segments: new vehicle car sales, used vehicle sales, financing and insurance, and parts and service. New vehicle sales made up 58.9% of revenues but only 13.5% of their gross profit in 2006. AutoNation makes most of their profits off financing and insurance, as well as the parts and services sales. These two divisions accounted for 58.6% of gross profits in 2006.

AutoNation has an advantage because they finance their new car inventories with car manufacturer’s incentives, which lowers the amount of working capital needed. This is beneficial since they make razor thin margins in their new car business. Once, the customer buys the new car, AutoNation cross sells them financing and insurance. When the car breaks down customers bring it back to the dealer to have repairs made, where AutoNation makes large margins. If the customer cannot afford a new car, AutoNation can always sell them a used car, the profit margins are much better than new cars.

An investor can still receive growth with AutoNation. They are the largest auto dealer but only have a market share of 2%, leaving plenty of room for consolidation. Over the past two years they have been selling poorer performing dealerships and purchasing luxury dealerships which have more stable cash flows.

It is interesting to note that AutoNation had 23 megastores, similar to CarMax’s superstores, but they closed this arm of the business completely by the year 2000. In the 1999 Annual Report management stated that “the megastores proved to be expensive to operate and required significant management resources. The megastores also couldn’t compete against a red-hot market for new vehicles, fueled by unprecedented factory incentives.” CarMax is building a brand by delivering a no-haggle solution to the customer on their price, but in the wrong market it seems consumers are incented more towards new cars.

AutoNation statistically is the cheaper auto retailer, though both are a decent purchase given their prospects. Investors usually will not often go wrong piggybacking off Lou Simpson or Eddie Lampert, but in this case the numbers seem to point to Lampert.

About the author:

Peter Lindmark
GuruFocus - Stock Picks and Market Insight of Gurus

Rating: 2.6/5 (31 votes)

Comments

texalope
Texalope - 7 years ago
My guess is that Carmax is attractive to Buffet because of its positioning in the market. They specialize in low mileage cars 3 years old or less. They offer warranties just like a new car dealer. My opinion is that many upper income new car buyers will shift purchasing habits in the coming economic downturn. KMX is well positioned to gain business. I don't see any economic moat. This is not a classic Buffet investment in my opinion.
texalope
Texalope - 7 years ago
as backup I would offer the following from the WSJ;

Credit-market stresses are moving from mortgages to auto loans, the Wall Street Journal reported Thursday. About 4.5% of 2006 auto loans to top-rated borrowers were at least 30-days delinquent in September, up from 2.9% in August, the biggest one-month jump in at least eight years

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