This article was selected to be shared with PRO subscribers, who also got 7 days’ exclusive access to Thomas Lott’s original Top Idea on Asbury Automotive (NYSE:ABG). Thomas Lott is a former hedge fund portfolio manager that currently trades for his personal account. Find out more about PRO here.
Seeking Alpha: Can you briefly summarize your bullish thesis for readers who may not have seen it yet?
Thomas Lott: Sure. Let’s just look at the numbers to start. This is a business that generates 33% returns on equity, 6% returns on assets, has grown EPS at 17% per year over the past five years, and expanded topline by 7% per year over the past decade. ABG never lost a dime during the Great Recession, and they have a conservative balance sheet too. Over half of their earnings are in high margin recurring businesses, and in many locales, they are a duopoly player. In the past decade, ABG holders have been rewarded with 21% annual returns, vs 13.6% for the S&P 500. $1000 put into ABG in 2010, would be worth $5920 today, vs $2580 in the S&P. That is 2.2x better than the S&P.
That said, auto dealers today trade at record high discounts to the S&P 500, roughly 50% cheaper than the market. This is despite the fact that Asbury will generate record earnings in 2020 and 2021, and clearly has a high quality, market beating business model.
The mispricing relates (we believe) to investors lumping dealers into the cyclical auto bucket. There is some cyclical noise, yes, but the reality is that, and anyone who owns a BMW or Mercedes knows this, these companies make most of their profits from servicing cars and financing them. So, while auto sales will be down 15% this year, ABG will likely book EPS of over $10 this year, up from $9.45 last year, and well over 2x what they did in in 2014, which was $4.40 in EPS.
We see no reason that Asbury cannot continue compounding earnings too, perhaps taking EPS to $20 in another 4-6 years. And where does this terrific, high ROE, high margin, business trade? Under 9x 2021 earnings, and just over 10x this year.
A couple notes specific to Asbury too. One, they just purchased 13 auto dealerships from Park Place Automotive, a Texas based luxury car dealer. The deal looks to be roughly 20% accretive to earnings next year. There is no better market to be in than in luxury autos, and in Texas, a very high growth region. These are premier assets. ABG will be 49% a luxury car dealer proforma. Luxury is less economically sensitive, as wealthy buyers are less impacted by recessions.
Two, Asbury actually owns their dealership properties. There is the potential to unlock tremendous value via a sale leaseback transaction. While not likely to happen, it is interesting to note that most retail REIT’s trade at 15-20x, while Asbury trades at 8x. The value is there, just hidden and not recognized by the Street.
Our one-year target simply uses its normalized EPS multiple 11.5x over the past seven years, and X $13 in EPS gets us a $150 stock. But I intend to own this one for a long time.
SA: You made a great point that the threat of disruption from companies such as Carvana or Vroom is much less than investors may assume – can you unpack this a bit?
Thomas Lott: Carvana is just another profitless revenue growth vehicle (no pun intended), that doesn’t even generate positive EBITDA. They are gaining market share, but in parts of the industry that just are not terribly attractive. They traffic in used cars only, and primarily are grabbing share from the mom and pop used car dealers out there, not necessarily the large-scale auto dealers.
And if you want a new car, you cannot go to Carvana or Vroom. Anyone buying a new car, often trades in their vehicle at the Lexus dealership for example. That gives Asbury a pretty large cost advantage on its used inventory vs Carvana. And with an exclusive line up of new car product, that means that there really is no digital “disruptor” to this industry.
Also, Carvana may capture share in the used car space, but they entirely lack the profitable parts & service side. Ultimately, and this is particularly true as car complexity increases, Carvana buyers will end up getting their autos maintained and repaired at a branded dealership.
As for a digital strategy, Asbury already sells fully 20% of their cars online anyway. They have apps to book car appointments, and loaners and pickup and delivery options make them pretty good at offering ALL the needs of a car owner today (from trade-in to upgrade to financing and repair). And they can do all this through a phone app.
SA: Do you think part of the mispricing is because investors are missing how attractive its business model and growth outlook is?
Thomas Lott: Investors absolutely miss how growth-y this industry is. Car sales tend to grow just under 2% per year, and yet ABG has been growing revenue in the mid to high single digits, and EPS in the mid-double digits ballpark over the past 15 years. Revenue growth did slow in recent years, but it has and we believe it will continue to accelerate as urbanites flee to the suburbs. Asbury also has the scale and capital structure that allows them to roll up smaller dealers with cheap financing.
To those of us that focus on high free cash flow, high margin businesses, it is pretty obvious how attractive this business model is. However, today’s investor seems obsessed with revenue growth only. Why do profits matter they say? That has led to a market of the haves and the have nots. Dozens of high-quality business models today trade at hugely discounted valuations, simply because they are seen as passe.
Carvana trades at 4.4x 2021 sales. EBITDA is expected to remain negative until 2023 per Street estimates. With about 20% of ABG’s revenue derived from digital sources, then just a 4.4x sales multiple on 20% of Asbury’s revenue would imply that ABG stock is worth $300 per share! Forget the other 80%. This is how crazy some digital names have become in this market. And Asbury actually makes money.
SA: How do trends such as the growth of electric vehicles (EV’s) and/or future outright ban of internal combustion engine cars impact ABG and the industry over the time horizon for this idea, as well as longer term (such as 5-10 years)?
Thomas Lott: It is possible that investors view traditional auto dealers as dinosaurs. Tesla has forgone a dealer network, and sells directly to the buyer. Why have dealers at all? This is a simplistic and unrealistic view of the auto world as we see it.
First of all, even electric cars require service and repairs. One dealer we spoke to said that while electric vehicles have fewer parts and require less frequent maintenance, they are far more expensive to repair. Over a five-year cycle, an EV Nissan Leaf costs about the same to maintain as a gasoline powered Toyota Corolla.
Tesla has 2% market share in the US. Near term, it is hard to see them taking enough share to really impact OEM dealer sales or Asbury. Long term, even if Tesla captures say 20% of the market in a decade (and I am pretty sure every other car OEM in the world will have something to say about that), then they still require repairs and insurance and financing. The profitable side of the industry seems pretty likely to be around for a long long time. The increasing complexity too of an electric vehicle means that mom and pop repair shops probably lose more and more market share to certified dealers’ repair shops.
And Tesla’s lack of a dealer network could create huge headaches for them. In the article we mentioned that Houston, a city of 7mm people, has only one servicing center for Tesla’s. When their Model 3’s start requiring real repairs and maintenance, then there could be major problems. There is literally no infrastructure to do so. Tesla owners are actually calling and asking ABG dealers to do repairs for them.
Thanks to Thomas for the interview.
Disclosure: I am/we are long ABG, LAD. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.