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AutoNation and the Cyclical Risk of the Auto Industry – Edward Lampert Starts Reducing
Posted by: Victor Selva (IP Logged)
Date: December 5, 2013 11:54AM

According to GuruFocus Real Time Picks, on Nov. 29 Edward Lampert reduced his stake in AutoNation Inc. (AN). By Sept. 2013, Lampert owned 29% of AutoNation's common shares; so what made him cut back his position three times during November?

The company operates as an automotive retailer in the U.S. The company operates in three segments: Domestic, Import and Premium Luxury. The first segment consists of retail automotive franchises that sell new vehicles manufactured by General Motors, Ford and Chrysler. The second segment consists of retail automotive franchises that sell new vehicles manufactured by Toyota, Honda and Nissan. The last segment consists of retail automotive franchises that sell new vehicles manufactured by BMW, Lexus and Mercedes. The franchises in each segment also sell used vehicles, parts and automotive services, and automotive finance and insurance products.

Cyclical Exposure

Although we think in an expanding U.S. economy and an improved credit conditions contributed, more than half of the sales were from new car sales. This segment is very sensitive to economic downturns, and is a major risk despite the favorable economic trends. Moreover, the effect of higher gas prices on sales will vary depending on which cars are being sold. It probably reduces sales of big trucks and sport utility vehicles. According to Experian Automotive a $1 rise in fuel prices caused trucks to lose about 0.5% in market share. The principal risk is that consumers shift to buy more fuel-efficient vehicles. Finally, the firm´s debt is at a variable rate and constitutes a major risk in a scenario of rising interest rates.


Let´s make a comparison with the peer group through the next table:

Ticker Name Mkt Cap EPS 1 Yr Growth P/E ROE Div. Yld
Average 6,999.7 20.0 19.8 18.8 0.5
AN AUTONATION INC 5,981.0 30.6 17.2 19.2 0.0
PAG PENSKE AUTOMOTIVE GROUP INC 4,004.9 11.5 16.7 17.3 1.3
KMX CARMAX INC 11,492.5 3.8 24.2 15.9 0.0
CPRT COPART INC 4,399.3 1.4 24.4 24.5 0.0
GPC GENUINE PARTS CO 13,033.9 15.5 19.8 22.4 2.6
ORLY O'REILLY AUTOMOTIVE INC 13,345.7 28.1 21.6 30.3 0.0
AZO AUTOZONE INC 15,610.0 17.6 16.5 NA 0.0

In terms of valuation, the stock sells at a trailing P/E of 17.2x, trading at a discount compared to an average of 19.8x for the industry. Moreover, for investors looking for dividends, Penske Automotive Group Inc. (PAG) and Genuine Parts Company (GPC) seems more appropriate.

Finally, I always like to see one of the most important financial ratios applying to stockholders, the best measure of performance for a firm's management: the return on equity. While AutoNation ROE of 19.2% is above the industry mean of 18.8% and also higher than Penske Automotive and CarMax Inc. (KMX), the ratio has decreased when compared to the same quarter one year ago (17.5 vs 18.57). I have to emphasize this because is a signal of major weakness within the company.

Final Comment

Although the growth in revenues has outpaced the mean industry, the net income growth has not. Moreover, ROE and liquidity decreased from the same period a year ago. In the third quarter, earnings per share (EPS) rose by 14% but still missed the Zacks Consensus Estimate by $0.03.

I would recommend following Lampert and staying away from AutoNation at this time. Other Hedge fund managers that reduce their position in the stock were Paul Tudor Jones, Murray Stahl, Mario Gabelli, Jeremy Grantham and Steven Cohen.

Disclosure: Victor Selva holds no position in any stocks mentioned.

Guru Discussed: Edward Lampert: Current Portfolio, Stock Picks
Stocks Discussed: AN, PAG, GPC, KMX,
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