The obvious beneficiaries of a boom in auto sales are the manufacturers, but don’t forget about the dealerships. Companies like CarMax, Inc (NYSE:KMX), AutoNation, Inc. (NYSE:AN), and Sonic Automotive Inc (NYSE:SAH) are primed to benefit as well. However, the market has already awarded each of these companies a generous multiple, so only the company with the best growth prospects is worth looking at.
Gauging Growth
If you look at historical growth, Carmax is the only company that is actually going anywhere. While Carmax grew revenues at an annual rate of 8.5% over the last 10 years, AutoNation barely kept pace with inflation and Sonic Automotive Inc (NYSE:SAH) experienced an overall decline in sales.
But the past is not always indicative of the future. AutoNation has wide margins due to its vast scale — it’s in a better competitive position than the other two. The company is also expanding its auto maintenance and repair business, which is the most lucrative part of a car dealership. In addition, the company has been recapitalizing its balance sheet by borrowing to finance share repurchases.
However, wide margins and share repurchases do not serve shareholders well if the shares are overvalued. While the company will continue to ride the wave of new car sales, its heavier exposure to new vs. used car sales makes it more vulnerable to a slowdown than its competitors. In addition, the company has not shown it will grow much faster than inflation, and there is little reason to doubt its historical growth rate will change for the better. As a result, it’s difficult to make an investment case for AutoNation where the shares trade now.
Sonic Automotive is another interesting company. Its dealerships have already rolled out maintenance and repair divisions, so AutoNation is playing catch-up. The company is more dependent on used car sales than new car sales. But the worrisome aspect of Sonic is its CEO. O. Bruton Smith is the chairman and CEO of both Sonic Automotive and Speedway Motorsports, Inc. (NYSE:TRK). It is a wonder how anyone can manage two companies whose combined market capitalization is over $1.3 billion. But shareholders won’t have any say in the matter — Smith and his son control three-quarters of the voting power at Sonic. It’s hard to jump on board a company where management isn’t fully committed to creating shareholder wealth.
That leaves us with Carmax. From 2002 to 2007, Carmax grew sales per share at a whopping 14.5% annual rate. The growth rate slowed considerably during the worst auto recession in recent history, but the company is beginning to show signs of resuming a high rate of growth. It is adding new stores at a healthy rate and comparable store sales are not suffering as a result. The company’s leading market share in the U.S. late model cars market enabled it to remain profitable during the recession, which suggests there is significant downside protection in the event of another downturn.
Conclusion
All three companies are priced for growth, but only Carmax represents the best growth opportunity. It has a long runway for growth in the U.S. and has demonstrated that it can remain profitable even during an auto recession that took out General Motors Company (NYSE:GM). So, for those who are bullish on car dealerships, sell AutoNation and Sonic Automotive and buy Carmax.
The article This Car Dealership Has a Long Runway for Growth originally appeared on Fool.com and is written by Ted Cooper.
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