Description

Asbury Automotive group is the seventh largest US franchised auto dealer that dominates the southeast US.  It has a ~$2 Bn Market Cap, ~$4 Bn Enterprise Value, and $9.4 Bn in 2020 revenues, $455M EBITDA, and $223M FCF (pro forma for a recent acquisition). ABG also has a long track record of industry leading returns, and margins, and a capital allocation policy which has had the company buy back ~1/3 of its shares outstanding over the last 4 years.  ABG is extraordinarily cheap at <10x EPS and a double digit fcf yield, but it is also a higher quality business that while cyclical, is far less so than is generally perceived. 

Auto dealerships are great businesses.  They operate under territorial exclusivity laws which protect dealerships by establishing monopoly market areas that reduce intra-brand rivalry.  ABG specifically has earnings which have compounded at 20% over the past decade, average returns on invested capital of just under 30% throughout the cycle and an asset light low capex profile which converts NI to FCF at an attractive rate. 

The internet has helped increase customer price transparency on the sale of new cars and reduce the “moat” on that part of the auto dealership business over the past decade.  ABG has seen new car sales gross margins erode from ~7% in 2006/2007 to around 4% today.  But local monopolies are stubborn things, and rather than losing overall gross profit dollars, those dollars have been effectively reallocated to better parts of the business: finance and insurance (which come in at 100% flow through margins) and parts & service (which is higher margin and significantly less cyclical).  Going into the global financial crisis, new vehicle sales represented 28% of gross profit in 2006, vs only 13.5% today.  Parts & service, by far their best business line, now represents ~50% of gross profit and ~65% of EBITDA.   We expect these trends to continue as parts & service grows faster than the rest of ABG, resulting in gradual multiple expansion as the market begins to appreciate just how good a business parts & service is. 

There are various secular tailwinds that will continue to drive the growth of P&S.  When you just look at the auto after care market across auto dealers, it is a stable, growing end market, growing in the MSD range.   Auto dealers have ~30% market share of the $287Bn total after care market and we believe that share will continue to grow.  Asbury, one of the larger auto dealers with greater scale has been growing 100 bps in excess of this, demonstrating that scale matters.  Further supporting the trend is that sweet spot of the car-park, cars aged 5 to 9 years, is starting to inflect upwards.  At this age, these cars come off warranty and typically entail greater service and greater customer pay which is the most profitable subsegment within Parts + Service.

Finally, as cars are becoming more technologically dense and complex, diagnosing and repairing vehicle parts will require more technology, training and scale that only select large auto dealer networks offer.   In the past, a minor collision such as a fender bender may have caused a day of service and a couple hundred dollars of repair work using after-market non-OEM parts at your local mom and pop collision center.  However today, a fender bender impacts technologies like sensors and cameras which are densely packed into the car’s body and drive multi-thousands of dollar of repair work.  Servicing and repairing more technologically complex cars requires proprietary OEM technology that will be replaced only through the auto dealer.  So we see a future for the Parts and Service business that drives up both total ticket per repair as well as the proportion of all repairs serviced at the auto dealers.

The closest analog to the P&S business are collision center businesses.  These include private players like Service King, Caliber, Abra and the main publicly listed collision center roll-up, Boyd.  P&S is similar to or better than, Boyd Group on several key metrics: returns (54% ROIC vs Boyd 42%), same store revenue growth (both MSD% since 2005) and gross margins (ABG 63% vs Boyd 45%). Boyd has consistently traded ~12X EBITDA, a multiple far greater than ABG at just over 8x.  As a purely intellectual gut check, if you took the Parts and Service as a standalone business we have a very recurring, highly profitable, high ROIC and recession resistant business with secular tailwinds, which, if it enjoyed the multiple similar to it’s closest peer, Boyd group, it would imply that we’re getting the New and Used Car business at a negative valuation.

ABG recently announced a $1Bn acquisition of Park Place dealerships, increasing their proportion of revenues tied to the luxury segment and their proportion tied to parts and service.  The luxury segment is, marginally less cyclical than the corporate average (luxury new car sales gross profit was down 17% in the GFC vs 21% for the company as a whole).  Park Place also has 56% of its total gross profits from parts and service vs 48% for ABG pre-deal.  The deal, while high quality did come at a big price (9x EBITDA). but also brings leverage above 3x until 2022 and likely keeps them away from any major M&A. 

We estimate that ABG will earn $12.30 next year pro forma for the Park Place acquisition and that free cash flow should approximate earnings. Revenue should grow at a 1.5-2% clip and EBIT/EBITDA around ~5% as the mix shift away from lower margin new/used sales and into higher margin parts and service continues.  With financial leverage and continued return of capital this should result in earnings/fcf per share growing at a healthy 10-15% over time, leading to strong returns even without a multiple re-rating.

In our downside case, we believe it’s more realistic to look at the prior two recessions before 2009, the financial crisis was unusual in that it was both severe and credit driven.  In the two prior recessions new car unit sales were down low double digits and used car unit sales were down only 2% on average.  Using 13% new vehicle declines, 2-3% declines for used and P&S, and a blended 10% decline in finance would lead to a HSD revenue decline and given the highly variable cost structure only a ~10% decline in earnings.  Worth noting should you choose to build out your own case, that floor plan financing is an operating expense they’re likely to get a benefit from as a result of lower interest rates in a recession (though admittedly, this is not nearly as a big a benefit as in the last recession given where rates are today).  Using these to inform our downside case on ABG, we estimate ~$11/share downside earnings case, implying today shares trade at under 10x P/E in a moderate recession case next year.

Catalyst

Continued growth of EPS and FCF

Possible continued rerating as parts and service becomes greater % of mix

Execution on integration of park place acquisition