Description

Asbury has been written up a few times on VIC and you can refer to those for more background on the company. Overall the business still has much more to run and see an attractive entry point on the recent pullback.

Summary Points

1)     Dealerships continue to be misunderstood by the markets and are great businesses

2)     ABG is the best run and has the highest margins vs peers

3)     E-commerce opportunity through Clicklane

4)     Valuable owned real estate portfolio

5)     ABG is the perfect acquisition target for LAD

6)     Inventories likely to remain constrained through FY23 which should continue to provide a tailwind to new and used car margins

7)     ABG has provided a longer term view to get to $20 billion in revenue by 2025

8)     Valuation is very compelling

Thesis

1)     Why dealers are great businesses (with examples specific to ABG) 

a.     Dealers own a majority of their land/real estate yet get very little credit for it. When comparing the dealers to other retailers it is noticeable that the operating lease expense is much lower. There are opportunities to monetize the real estate if the dealers choose to go down that path. There is a REIT trading in Toronto called Automotive Properties Real Estate Trust that specializing in pursuing these sale-leaseback transactions as an example. 

b.     Dealers are resilient through the cycle. ABG has had positive FCF every year since 2007 (In 2008 they purchased $208 million in real estate, without this purchase they generated close to $150 million in FCF). I back out working capital given it is heavily driven by inventories which is tied to floor plan financing which is non-recourse and skews the real underlying FCF of the business. 

c.      Dealers have historically traded for high single digit to low teens P/Es, yet have grown earnings ahead of the market and generate double digit ROIC. ABG has grown EPS at a 16% CAGR from 2007 to 2019, if I include FY20 & FY21E that CAGR goes to 20%. This level of growth is inconsistent w/where the multiples have historically traded. In addition over the last 5 years ABG has averaged ROIC above 13%. 

d.     Parts & Service make up 50% of gross profits and have historically been a very stable and growing piece of the dealer business. This business historically is not very closely tied to SAAR and instead tied to warranty, reconditioning, repair and collision work. As vehicles get more complex and require more diagnostics and tools to repair, the dealers should continue to take share from mom/pop mechanic shops. 

e.     Today Inventory / floor plan financing should be viewed as an asset not a liability. All dealers carry floor plan financing on their balance sheets which is non-recourse debt tied to the level of inventories on their lots. Typically the dealers screen poorly on leverage because of how it is defined by bloomberg/factset. However, my view is that this is an asset not a liability as dealers are typically paid to have inventory on their lots and don’t really own the inventory. In the last 12 months, Asbury made $44 million in pre-tax profit due to the receipt of incentive payments outweighing the interest expense on the debt facility. Now there are a few factors that are helping the dealers  1) inventories are not staying long on the lot 2) interest rates are low 3) they are still receiving floor plan assistance from the OEMs. In the 08/09 downturn floor plan assistance from the OEMs was not enough to offset higher interest expense and inventories were taking longer to move. In that environment the floor plan financing was a true liability. So one needs to be mindful that there is some risk that comes from it but in general this has been a benefit. Chart below shows quarterly net benefit received from the facility for ABG since 2007 which has averaged $8.3 million/year which is a direct benefit to pretax profits.

2)      ABG is the best run auto dealer

The company retains the highest Gross & EBITDA margins vs peers. They also produce consistent profitability given the lower quarterly variability in the historic gross margin. This provides a competitive advantage when going after acquisitions as the company can use their playbook to boost profitability on underperforming dealer acquisitions. Chart below shows average quarterly gross profit margin since 2007 for all the publicly traded dealers:

3)     E-commerce opportunity through Clicklane

Clicklane is Asbury’s branded online e-commerce platform that lists all the new & used cars at their dealerships. This platform is somewhat differentiated from existing car e-commerce platforms like Carvana, Shift & Vroom in that they are able to sell new cars. The existing used car e-commerce providers do not have franchise agreements w/OEMs and thus are focused only on used cars. Given the franchise agreements, Asbury along with other car dealers are only allowed to market new cars within their locally agreed franchise area. This creates more of a need to expand geographically to leverage the platform across a larger geographic area in which to market new & used cars. Clicklane is additive to their existing footprint because Asbury does not need to add infrastructure to support the platform. This will allow them to take market share from smaller dealer groups that do not have the ability to market vehicles online successfully.

I estimate that today Clicklane is worth about $1.3 billion when comparing it to existing used car e-commerce players. I conservatively assume the front end yield is lower than what ABG is producing today and declines for the next few years.

4)     Valuable owned real estate portfolio

Asbury has spent over $650 million on real estate since 2007. On the books ABG has ~$400 million of land at cost. Using Automotive Real Estate Properties as a bogey for ABG’s real estate valuation, I come up w/a market value of about $12.4 million/owned property x 76 owned dealerships = $942 million of real estate vs $512.7 million of real estate related mortgage debt for a net value of $430 million.

5)     Why Lithia will likely buy or merge w/Asbury

The more I dig into this industry, I realize there are two players that perfectly fit together as they are both going after the same acquisition & online growth strategy yet operate in mostly different geographies. Some of the major benefits are as follow:

a)     Expand geographic footprint. ABG has a strong presence in the southeast where LAD is largely absent w/ < 5% of revenues coming from this region. There is also minimal brand overlap in cities where they share a dealership presence as seen in the chart below (note there has been a lot of acquisition activity by Lithia YTD, so have not been able to include everything, however most of what they have purchased is not in ABG markets):

b)     The pursuit of a similar online strategy. Lithia is aggressively expanding their retail footprint in order to make their online e-commerce platform, Driveway, a household name. ABG is also pursuing a similar strategy through their online platform, clicklane. Combining these efforts would save SG&A dollars as well as expand their advertising dollars over a larger geographic footprint. The more scale and geographic exposure you have, the better ability to market new cars online and create a unified national brand vs local one. 

c)     Limited brand overlap. The only material overlap between the two companies is w/Honda & Toyota. There would likely be limited divestment and I don’t see a barrier to getting the sign-off from the OEM brands as the combined revenues would still likely be small relative to the OEM’s overall pie.

d)     ABG is the best run dealer w/the highest margins. There is an opportunity to leverage the ABG model to the rest of LAD’s footprint to boost profitability 

e)     Synergies. Opportunity to reduce corporate costs and over time reduce cost of capital while pursuing further acquisitions.

f)      Similar growth strategy. Both companies have put out 2025 revenue & EPS growth targets through a mix of acquisition, online & organic growth.

6)     Inventories likely to remain constrained through FY23 which should continue to provide a tailwind to new and used car margins

Dealers have been benefiting due to lack of supply which is driving the SAAR rate towards current levels of production. It is clear this is a supply driven market today as used and new car margins are very high for the dealer group and incentives are hitting new lows. IHS recently took a hatchet to their forecasts for FY21 production due to the shortage of semiconductors. It is now expected that North America production will be almost flat YoY and not expected to show meaningful quarterly growth until 2Q22. New car inventory days are at a very low point, which is driving margins for new cars and providing better pricing for used cars.

It is not expected that new car inventory days will normalize around 60 until after 2023 given current production schedules, which means the higher margin environment for the dealers is likely to continue at least through 2022/2023. There has also been some scuttlebutt that OEMs are looking to produce consistently at 40-50 days moving forward due to the margin benefit they are all seeing from running inventories lower than the 60 day level. I have a hard time believing this will work given competition, however dealer margins can maintain at higher levels if they work at achieving lower level of inventory days moving forward.

7)     ABG has provided a longer term view to get to $20 billion in revenue by 2025

This was a 5 year target set out in 2020 which set to deliver 20% Rev CAGR over 5 years through $2 billion in same store revenue growth ( ~6% organic CAGR), $5 billion in sales from Clicklane – which is also organic and would have to assume ramping to ~150k used/new unit sales just from online, and $5 billion in sales from acquisitions. Assuming they hit their targets, I estimate that in 2025 they could generate $33/share in EPS assuming some reversion in margins due to normalization of inventories. If I assume ABG can retain margins which very few do, that would be closer to $43/share in EPS.

8)     Valuation is very compelling

The market typically values the dealers on a multiple of earnings. The dealers P/Es have historically traded between 6 – 15x and more recently they are trading around 8x next year EPS. Many have the view that EPS has peaked at dealers due to the outsized margins being generated today due to inventory shortages. You can see this in estimates as the market has earnings for all the dealers declining relative to 2021 over the next 2-3 years. Although it is very likely this higher margin environment is transitory, I believe the public dealers will continue to take share from private dealerships and there will be much more consolidation which should help boost profitability. In addition, the online opportunity should help augment margins higher over time. Given the level of profitability (double digit ROIC), quality/resiliency of the business, and growth opportunity, I feel a much higher P/E is warranted. Taking my 2025 EPS of $33 and conservatively using an average 10 year 11x P/E I would get a $360 stock which is a double from where the name trades today. If you assume no multiple re-rating, ABG trades at 8.5x FY22 estimates, which would still equate to a $280 stock or 56% higher than today. I also attempted to put together a SOP valuation below which gets you a $430 stock price.

Risks 

1)     What does the dealer business look like in 10 years? Very tough to answer this question, does autonomous vehicles render the dealer networks obsolete as car ownership moves to bigger companies providing ride share services? Think the business might ultimately evolve towards parts & service which is the bulk of the profitability. I think car ownership will be here to stay for at least the next 10-15 years, beyond that hard to foresee but the dealers have a very long runway here. 

2)     Fear of OEM going direct to consumer – I believe by going direct you are foregoing a network that can help service your customers. Think of recall activity, warranty issues, relationship - the traditional OEMs don’t have this direct with the customer and I am not sure it is worth it for them to move in that direction. Other than Tesla, the EV industry ex traditional is still nascent. I think the traditional auto makers will be able to put out as compelling of an offering as any EV maker and can’t see them moving away from their franchise network as it is a competitive advantage in local markets. 

3)     Does EV proliferation change the way dealers operate their business? As smaller EV only companies get bigger, I could see announcements in the future to partner w/AN or LAD or other national footprints to sell and service vehicles. This immediately gives those auto companies access and distribution no different than any business trying to sell a product nationally. 

4)     Parts & Service may be impacted by EVs as vehicle complexity declines - Dealers are already taking share from mom & pops as the auto becomes more complex. The EV engineering might be less complex but the tech inside the vehicle (all electronics etc..) is more complex. It requires more well trained technicians and the dealer group is what keeps these folks current and has the capital to stay relevant here.

5)     Any increase in tax rate will directly hit the dealers – they are very exposed 

6)     Floor plan facility and benefits received are exposed to interest rate movements – higher interest rates will have an adverse affect on the business

Catalyst

1) Acquisitions

2) Online unit sales

3) If most of the margin improvement during covid retained, would be a home run