The slow-but-upward climb of the United States economy has lifted domestic automobile sales along with the auto industry’s top line. The recent increase in auto sales is likely due to consumer deleveraging during the Great Recession; with cleaner balance sheets and rising income, consumers can finally afford to buy new cars again.
Although General Motors Company (NYSE:GM), Ford Motor Company (NYSE:F), and even Tesla Motors Inc (NASDAQ:TSLA) will undoubtedly benefit from the increase in auto sales, investors should look further down the line for bargains. Car dealerships, including CarMax, Inc (NYSE:KMX), Sonic Automotive Inc (NYSE:SAH), and AutoNation, Inc. (NYSE:AN) are not receiving as full a valuation as the auto manufacturers considering their growth prospects.
Paying for growth
Of the three dealerships, investors have the clearest picture into the future of CarMax. CarMax, Inc (NYSE:KMX) has grown revenues at a high-single digit annual pace over the last decade, whereas AutoNation, Inc. (NYSE:AN) and Sonic Automotive Inc (NYSE:SAH) grew at a much slower rate.
However, AutoNation and Sonic Automotive may soon see their fortunes reversed. AutoNation’s enormous scale gives it a cost advantage over CarMax, Inc (NYSE:KMX) and Sonic, which is an important competitive advantage in an industry with few competitive barriers.
More important, however, is AutoNation, Inc. (NYSE:AN)’s increasing focus on its maintenance and repair business. The maintenance and repair division is the most lucrative segment of all car dealerships, so an increased focus on this aspect of its business will allow AutoNation, Inc. (NYSE:AN) to grow earnings at a faster rate than history would suggest.
Of course, AutoNation, Inc. (NYSE:AN)’s heavy exposure to new car sales makes future growth in this segment difficult to project; if new auto sales continue to increase, so will AutoNation’s sales. But when the cycle stalls, AutoNation’s revenues will fall as well.
Sonic Automotive Inc (NYSE:SAH), on the other hand, is already a strong performer in the lucrative maintenance and repair segment and is focused on the more reliable used car market. The business is great, but corporate governance is not. CEO Bruton Smith splits his time between Sonic Automotive Inc (NYSE:SAH) and Speedway Motorsports, Inc. (NYSE:TRK)— two public companies under one CEO. Even if shareholders were to grow concerned about Smith’s ability to manage both companies, there is little they could do about it; the Smith family controls a majority of the voting power and can do whatever it pleases with the company. As a result, investors should be cautious before investing in Sonic Automotive Inc (NYSE:SAH).
CarMax, Inc (NYSE:KMX) , however, is seemingly hair-free. The company has grown sales at 8.5% per annum over the last 10 years and has repurchased shares so that the sales per share growth rate is even higher. Although growth slowed during the Great Recession, it is already showing signs of a rebound.
More importantly, CarMax, Inc (NYSE:KMX) remained profitable during the recession due to its number one share of late model U.S. car sales. As a result, investors who buy CarMax benefit from its tremendous growth potential while being shielded from another downturn in the economy.
At 0.8x sales, CarMax, Inc (NYSE:KMX) is priced for growth but not extreme growth. The company will inevitably grow into its current valuation, and could easily surprise to the upside — giving shareholders an outsized return.
Bottom line
The market is not fully accounting for the growth opportunities available to car dealerships, but AutoNation, Inc. (NYSE:AN) and Sonic Automotive Inc (NYSE:SAH) have too much hair to be worth consideration. Only CarMax has the great business model to go with the reasonable valuation that investors should expect.
The article This Dealership is Outgrowing the Competition originally appeared on Fool.com is written by Ted Cooper.
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