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  1. Home
  2. / Investing
  3. / Stocks

7 Ways to Drive to Profits in the Used Car Market

From auto parts to car auctions and online sales, these stocks could put more pep in your portfolio.
By MONEYSHOW.COM
Jul 31, 2019 | 05:00 PM EDT
Stocks quotes in this article: AZO, FDX, ORLY, KMX, KAR, IAA, CPRT, LAD, CVNA

When considering automotive investments, many look only to the large, well-known carmakers. However, several leading experts and contributors to MoneyShow.com see better opportunities in used cars and auto parts as well as car auctions and online sales.

David Fried, The Buyback Letter

Memphis-based AutoZone  (AZO) will be a familiar name to veteran subscribers of our Premium Portfolio, since we bought and sold it a handful of times in the past 14 years. We had spectacular results from our purchase in 2010 (a 35.89% gain), and most recently, we bought in 2011.

AutoZone is the nation's leading retailer and a leading distributor of automotive replacement parts and accessories with more than 6,300 stores in the U.S., Puerto Rico, Mexico and Brazil.

Each store carries an extensive line for cars, sport utility vehicles, vans and light trucks, including new and remanufactured hard parts, maintenance items and accessories.

Since opening its first store in 1979, AutoZone has joined the New York Stock Exchange and earned a spot in the Fortune 500. It has more than 90,000 employees it calls "AutoZoners."

It's been one of our favorite companies over the years because it makes money and grows profits. In recent times, the company's CEO has been proud of the company's innovation, including a partnership with FedEx (FDX) on things such as next-day delivery and the FedEx Same Day Bot.

The stock hit a 52-week high this month, including a 30%+ gain since the beginning of the year. For the current fiscal year, AutoZone is expected to post earnings of $62.48 per share on $11.82 billion in revenues (a 24.12% change in EPS on a 5.34% change in revenues).

For the next fiscal year, the company is expected to earn $65.65 per share on $12.1 billion in revenues (a year-over-year change of 5.08% and 2.32%, respectively).

AutoZone has long been an active and committed repurchaser, so much so that financial pundits have joked that it sometimes looks like the company is taking itself private on an installment plan. AutoZone continues on that road, having reduced shares outstanding by 7.214% in the last 12 months.

Garrett Nelson, CFRA Research's The Outlook

Our latest focus stock of the week is O'Reilly Automotive  (ORLY) which carries our highest investment recommendation of 5-STARS, or Strong Buy. The company is one of the largest U.S. retailers of automotive aftermarket parts and accessories, with 5,306 stores in 47 states as of March 31, 2019.

The company's top states in terms of store count are Texas and California, which together comprise just under 25% of its total. Stores located in seven other states -- Missouri, Georgia, Illinois, Florida, Ohio, Tennessee and Michigan -- account for another one-quarter of the store count.

The company has a dual market strategy, targeting Do-It-Yourself (DIY) customers as well as Do-It-For-Me (DIFM) customers (auto repair shops). In FY 18, 57% of the company's sales were to the DIY market and 43% to DIFM customers.

Our positive investment view reflects positive auto aftermarket fundamentals being driven by a record-high U.S. average vehicle age (11.7 years at year-end 2018), an opinion that ORLY is a high quality name (~53% gross margins) with a history of returning capital to shareholders via share repurchases and a stock that historically performed well during periods of slower economic growth.

We think the stock's growth will be supported by solid comp sales growth of roughly 4%, 200+ net new store openings in 2019 and market share gains at the expense of certain auto aftermarket competitors.

The company has a long history of profitable and aggressive "greenfield" growth, adding new stores to increase market share across its existing footprint and expanding into new markets. The company has opened at least 170 net new stores each year since 2011.

In May, the company announced an additional $1 billion share repurchase authorization, raising its aggregate authorization to $12.75 billion. The basis of our 12-month target price of $460 is 22.7x our 2020 EPS estimate, in line with its five-year average forward P/E multiple.

Doug Gerlach, Investor Advisory Service

CarMax  (KMX) , a used car retailer, reported better-than-expected first-quarter results. Sales increased 12% with used unit sales in comparable stores up a strong 10%. Management attributed the good results to a variety of factors including healthy conversion, solid growth in web traffic, a robust lending environment, and a shift in the timing of some tax refunds.

Store traffic in the quarter remained relatively unchanged. Generally stable margins led to nearly 12% earnings growth while share repurchase activity drove nearly a 20% increase in EPS.

The company highlighted continued progress in its important omnichannel efforts. Management indicated it is pleased with its results to date in Atlanta, which served as its roll-out market. The Atlanta market experienced double-digit comparable store sales and outperformed the overall company.

The omnichannel effort is expected to be one of the key drivers of comp sales and market share growth going forward. The company is on track to provide its omnichannel experience to the majority of its customers by the end of this fiscal year. CarMax is a buy up to $74.

Meanwhile, on June 28, KAR Auction Services  (KAR) completed the long-planned spinoff of its salvage auction business, IAA Inc.  (IAA) . With the spinoff, each KAR shareholder received one share of IAA stock.

KAR Auction Services continues to house the whole car auction business as well as a financing operation that primarily supports that business. The strategic thinking behind the separation makes sense, as each company is well positioned as an industry leader in what is effectively a duopoly.

While both companies possess interesting growth prospects, the opportunities in front of each differ as do the priorities for capital allocation. It is also believe that IAA Inc. will benefit from a cleaner comparison to Copart  (CPRT) , another online used car auction operator that is also in our portfolio. We are adding IAA Inc. to our coverage and continue to rate KAR a buy up to $22.

Mike Cintolo, Cabot Top Ten Trader

We're fascinated by the publicly traded car dealerships since we, along with most everyone else in the world, hates walking into a dealership to buy or lease a new car. But by analyzing these companies you can see where car dealerships make the most money -- in financing (including extended warranties) and used cars.

Beyond that, we like Lithia Motors  (LAD) because the stock is doing well and the fundamentals are solid. The company operates over 180 dealerships in 18 states across the country, through which it sells almost 30 brands of new and used cars and light trucks.

New vehicles make up just over half of sales, used cars about a quarter, and service, wholesale cars, insurance, etc., make up the balance. Lithia has differentiated itself from the competition by excelling in those higher margin used-car sales, which also feed into its parts and service business.

The bottom line is that revenue and EPS have been growing in the double digits, in part because of acquisitions, and the stock just broke out after a better-than-expected second-quarter report last week. Revenue was up 4.2% to $3.2 billion, while EPS of $2.95 beat by $0.13. Analysts liked the quarter, and with a strong balance sheet see Lithia snapping up more dealerships to keep the growth trend alive.

Lithia Motors peaked near $120 last March and was cut in half by December, but the stock's advance this year has been both smooth and powerful, with shares zooming back to 110 in April (including nine weeks up in a row). The stock crawled higher for a couple of months after that, and after a shakeout two weeks ago, The stock recently surged on earnings, so if you want in, aim for dips.

Meanwhile, Carvana  (CVNA) is revolutionizing the gigantic used car business ($760 billion) in the U.S. by selling online, providing not just better prices ($1,000 average savings per vehicle), but a ton of selection (more than 18,000 choices, gotten from auctions, off-lease and off-rental, etc.).

It also has a user-friendly, photo- and video-rich website and app (360-degree views of the car; purchases can be completed in as little as 10 minutes), ancillary services (buying trade-ins, providing financing) and offering important guarantees (no car it sells has ever been in a reported accident; most have a seven-day "test drive" period after purchase).

From an investment point of view, the main attractions here are the rapid revenue growth and still-huge expansion potential (selling in 85 markets at year-end 2018, rising to 140-plus by end of 2019, bolstered by a huge and growing logistics network) but also the very encouraging sub-metrics.

While earnings remain deep in the red, gross margin per car sold is rising nicely (expected to rise 20% this year to $2,550), and most new markets are producing steady market share gains (its oldest markets have achieved near 2% share). Analysts see revenues up 85% this year and another 53% next, both of which are likely low. Earnings are due Aug. 7.

Technically, Carvana has rested for the past 10 weeks, but that is really part of a 10-month consolidation -- the shares topped out last September, fell by 60% during the market's implosion, but then rallied all the way back to new highs by late April.

Super-deep corrections usually lead to a shallower consolidation, and that's what we've seen since the start of May. If you're game, you could nibble here with a loose stop and see if a breakout comes before or after earnings.

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TAGS: Fundamental Analysis | Investing | Stocks | Automobile Components | Automotive | U.S. Equity

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