Description

Summary / Background

Asbury Automotive Group, inc. (“Asbury,” “ABG” or the “Company”) is the fifth largest franchised automotive dealer in the US. ABG has been written up three times on VIC in the last three years so I will refer you to those (particularly cupmachine314’s excellent pitch) for background on the Company and its history to keep this succinct.

Since cupmachine314’s write up from last September, ABG has completed the transformative Larry H. Miller acquisition and utilized the robust operating environment to delver its balance sheet, which will provide Asbury with capital allocation flexibility going forward.

By way of brief background, Asbury currently operates 148 dealerships and 34 collision centers (the Company owns the vast majority of its dealerships and collision centers) with concentrations in the Southeast and Southwest U.S.

Asbury is a best-in-class operator with margins and operating KPIs that consistently exceed other publicly traded dealership groups. Unlike AutoNation, which typically rebrands all acquired dealership under the AutoNation banner, Asbury’s acquisition strategy wconsists of acquiring the best dealerships in metro markets (e.g., Park Place in Dallas, Nalley in Atlanta, Mike Shaw in Denver, Larry Miller in Salt Lake and Phoenix), leaving that branding intact, while generally improving F&I profitability at the acquired dealerships.

In addition, ABG has an admirable track record of capital allocation, reducing share count by nearly a third since 2010 while adding ~60 net new dealerships that has enabled the Company to compound EPS at a ~34% CAGR over that period.

Despite this, at current prices, I believe Mr. Market is effectively saying that auto dealers are significantly overearning and have little to no terminal value in an EV world. I believe both of these concerns to be overblown and therefore Mr. Market is offering the patient investor a compelling risk / reward profile next to the best operators and capital allocators in the car dealership space.

Thesis / Why the Opportunity Exists

1.      Fears Regarding EV Transition Overblown

While I do not believe that the transition to EV will be uniformly positive for all car dealers, I think that consolidators, and especially well-run groups like ABG are relatively well-positioned for an EV transition.

Ford recently made its dealers aware of the conditions it requires in order to remain a Ford EV dealer, which it estimates will cost dealers $1mm+ in capex and require transparent, no-haggle pricing. Given franchise laws (which vary state by state but generally serve to protect car dealers from manufacturers), in order to incentivize dealers to make these investments, the OEMs will almost certainly have to extend dealership agreements to limit DTC OEM sales for at least 5 – 10 years after Ford begins selling Model Es in 2027.

I also believe that no-haggle pricing will benefit, better run, higher margin dealers like Asbury relative to independents. I believe that as a metro focused dealer, ABG is likely to benefit from higher unit volume when EV ramps as I think that rural dealers are less likely to make those investments as the economics of doing so may not make sense, which will cause more new car volume to shift to metro dealerships.

Finally, I think it is unlikely that manufacturers ultimately actually want to really go purely direct to consumers because that would make them responsible for service and repairs, which has proven to be the chokepoint for Tesla. The Tesla Ranger service model is wildly inefficient compared to a service center with 20 - 30 bays where a technician can time stack repair as opposed to driving to individual homes. I think it is highly unlikely that the car manufacturers have a legitimate alternative to the dealer service model.

2.      Dealers are Not Overearning (or at least not that much)

It has been well documented that car dealers have had very little new and used car inventory over the last couple of years resulting in gross profit per units (“GPUs”) that are well above pre COVID levels.

What I think is less well understood is that the lack of new car production meant that dealers have been selling many fewer new cars that replacement demand (generally believed to be ~17mm SAAR). The new car supply / demand imbalance played a significant role in recent new and used car pricing / profitability dynamics and unlike other industries (eg RVs), is likely to persist well beyond 2022. Anecdotally, dealers are not expecting manufacturers to “return to normal” until 2024 or even 2025. Consequently, I believe that new vehicle GPUs are likely to have a softer landing than other industries at a time when there should be more new units sold than in the last couple of years thereby resulting in relatively stable new vehicle gross profit dollars.

I do agree that used vehicle GPUs are likely revert to the mean more quickly but given that used vehicles represents ~13% of ABG’s 1H ’22 gross profits, this in itself, is unlikely to move the needle from a Company-wide earnings / FCF perspective.  

3.      ABG’s Margin Floor is Above 2019 Margins

While bears will point to ABG’s margins relative to 2019 and forecast a regression, ABG’s leadership has been quite clear that it respectfully disagrees with this view:

“I would say this, I've said it in past quarters, so I'm going to stay consistent with it. Even if inventories normalize and we get back to pre-pandemic inventory levels, you won't see us get back to pre-pandemic margins -- or I shouldn't say margins, gross profits per vehicles. I think we're a different company.

I think it's a different time and space right now. And I think you'll see elevated margins from pre-pandemic levels going forward even as the days supply grows.” David Hult (CEO), Q2 ’22 Earnings Call

Beyond the aforementioned supply / demand dynamics, on reason that ABG’s margins should be structurally higher now than pre-COVID is Total Care Auto (“TCA”), which was acquired as part of the Larry H. Miller transaction. While car dealerships generate high margin finance and insurance (“F&I”) income as on the sales of new or used vehicles, TCA is an integrated insurance provider that effectively enables ABG to own a greater share of the F&I value chain. Revenue generated from TCA is much higher margin than new and used car sales (~50% gross margin after intercompany eliminations). Management believes that TCA will deliver $185mm of 2025 EBITDA thereby helping to raise Company-wide margins vs 4.6% in 2019.

While management is targeting $32bn in 2025 revenue, even if we were to say that Clicklane does not grow as expected and the Company is not as acquisitive as it hopes. I believe that at $20bn of revenue, ABG can generate $30 – 40 in FCF per share with upside to $40 – 50+.

4.      ABG is Cheap

Based on the above, I believe that ABG can reliably generate $30 – 50 in FCF per share over the coming years. While I think reasonable people can disagree on what that is worth, I believe that it is certainly worth more than the 3 – 5x the market is current offering. This is not a TV broadcaster with 4 - 5x turns of leverage and therefore do not think that low levered <2x cash flow producers are likely to be priced at 20 – 30% cash flow yields forever.

It is worth keeping in mind that the value of ABG’s real estate portfolio is likely worth at least $1.5bn (using cupmachine’s $942mm estimate and adding the $740mm acquired in the Larry H Miller transaction), which amounts to nearly a quarter of ABG’s TEV and can serve as an important source of financing.

5.  Clicklane Upside Optionality

While one does not need to believe in the success Clicklane in order for this investment to work, if ABG is able to create an omni-channel used platform, one needs to look no further than KMX to realize that the current multiple ascribed to ABG is wrong.

Catalyst

Share count reduction

Buyout / Merger

Time