AutoNation Revs Its Engine

 | Oct 21, 2011 | 10:45 AM EDT
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Red Sox Nation may be in disarray, but AutoNation (AN) hasn't struck out yet. In fact, in the last five years, AutoNation has outperformed the S&P 500, Ford (F), General Motors (GM) and Toyota (TM). Apparently selling cars is a better business than making them is -- and I believe AutoNation can continue to drive higher.

AutoNation is the largest automotive retailer in the U.S., owning and operated 257 new vehicle franchises in 15 states. The company sells new and used vehicles, arranges financing and sells spare parts. Investor Eddie Lampert owns 54% of the outstanding shares, and Bill Gates owns 16%.

I believe AutoNation revenue is poised to rise 11% for 2011 and about 12% next year, as I expect the economy to incrementally improve and push car sales higher. Most analysts are expecting new light-vehicle sales of 13 million in 2011 and 14 million in 2012. Used car sales remain strong, and prices have continued to rise.

In all, AutoNation's sales have been steadily recovering after bottoming out in 2009, when the company reported revenue of $10.7 billion. On Thursday the company reported that third-quarter revenue rose 7% to $3.5 billion, driven by higher average selling prices for new and used vehicles. Unit sales of cars fell 2%. Used vehicle sales increased 7%. Parts and service climbed 2%, and finance revenue was up 9%. Management blamed the decline in unit sales on the after effects of the Japanese earthquake. Operating income rose 19% to $144.1 million -- and, as with all Eddie Lambert-controlled companies, the company bought back $247 million worth of stock.

The Street is forecasting fiscal 2011 revenue of $13.5 billion, which would represent a year-over-year rise of 8.8%, while 2012 targets are at $14.6 billion, according to Thomson Financial. If you believe the U.S. is in a multiyear auto recovery, the stock should continue its march higher simply based on increasing light vehicle sales. In reality, $14 billion in revenue is what the company did in 2008, and it reported peak operating income of $888 million in 2005. The company has been aggressively paying down debt. Long-term debt peaked at $3.9 billion in 2007 and has been cut by about 65%.


AutoNation is not an earnings story, and you really can't evaluate it on an earnings-per-share basis. (If you did, the stock would probably be overvalued by 25% to 30%.) AutoNation's stock is financially engineered to go higher, as is characteristic of Eddie Lambert-controlled companies. The company uses leverage and its free cash flow to buy back tremendous amounts of stock, forcing the shares higher.

As long as auto sales improve next year, the stock should move higher, since the company should generate enough cash to shrink the shares outstanding. Hedge fund investors understand this, and have followed Eddie into the shares. While I don't like the engineering aspect, I recognize it for what it is -- a high octane play on future auto sales that hopefully won't drive you off a cliff.

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