June 6, 2023


Automotive and technology

AutoNation And Carvana: A Tale Of Two Auto Retailers


Portrait of a salesman working at the dealership showing cars outdoors

Hispanolistic/E+ via Getty Images

Americans love their automobiles. The automotive industry began in the US in the 1890’s and soon became the largest in the world after Henry Ford introduced mass production of cars starting with the Ford (F) Model T in the early 1900’s.

Model T production line

Model T production line (Brittanica automotive history)

Over the past 100 years and especially in the second half of the 20th century, global auto production increased in other countries such as Germany, Japan, Italy, France, and South Korea. In the early 2000’s the US entered a recession after the 9/11 attacks and the auto industry in the US was severely impacted by declining sales and profitability.

More recently, the US auto industry suffered another crisis from 2008 to 2010 due to the economic downturn that we now refer to as the Great Recession. As a result, and since that time the auto industry has become much more globalized. For example, Chrysler Corporation, which was formerly one of the Big 3 US auto companies, is now foreign owned:

In January 2021, Fiat Chrysler merged with Groupe PSA hence making FCA’s North American operations (including Dodge, Chrysler, Jeep and Ram) part of a brand new parent entity named Stellantis, which is headquartered in The Netherlands.

How do Americans Buy Cars?

Auto retailers generally fall into two broad categories now – those that own physical dealerships, like AutoNation (NYSE:AN), and those that sell cars online like Carvana (NYSE:CVNA). In this article, I will look into some of the reasons why I believe that AN is better positioned to grow earnings in the future and represents a better value and a Buy at the current price, while CVNA is likely to struggle to maintain profitability with significant expenses and lower margins and is rated a Sell at the current time.

The trend toward a more global supply of automobile manufacturers has led to auto retailers diversifying their offerings. No longer is it necessary to go to a Ford dealership to buy a new car from Ford. The changes in the auto industry that led to the Big 3 losing sales and market share in the early 2000’s led to a decision by former CEO Mike Jackson of AutoNation to change their sales strategy.

In 2006, Mike Jackson, CEO of AutoNation announced that his company would be reducing orders from General Motors, Ford and Chrysler in 2007. Jackson made the statement that the company will instead focus on selling BMW, Mercedes and Lexus vehicles due to anticipation of further market share loss by US automakers resulting in high dealer inventories.

Now, AutoNation prides itself on offering a wide variety of premium auto brands at its 129 JD Power 2022 Dealer of Excellence store locations across the country.

Q122 Earnings Presentation

Q122 Earnings Presentation (AutoNation)

The Rise (and Fall) of Online Auto Retailers

More recently, sales of new and used cars in the US have been offered through online retailers such as CarGurus (CARG), founded in 2005, and Cars.com (CARS), which started operations in 1998. Realizing that the trend toward online sales of cars was growing, the founders of Carvana (CVNA) established their retail business in 2012. To differentiate themselves from the competition, Carvana offered 100% online buying experience, contactless delivery of cars, online financing and insurance offerings, and the unique purchasing concept of car vending machines. As of May 5, 2022, Carvana operates 32 car vending machines in the United States. It was a perfect setup for the pandemic environment.

Carvana vending machine

Carvana vending machine (Carvana.com)

As auto sales in the US took another hit as a result of the Covid-19 pandemic with sales declining overall in 2020, the online buying experience worked in Carvana’s favor, especially when dealers that only have a physical presence had to close their doors.

Vehicle Sales History 1976 - 2021

Vehicle Sales History 1976 – 2021 (Statista)

Despite the downturn in sales, Carvana became the fastest growing online retailer of auto sales. According to an article in Forbes in November 2021, some people believed that online auto sales would become the new post-pandemic preferred method of buying cars.

At the time, Carvana was doing well, and sales were increasing dramatically compared to traditional retailers due to lockdowns and the stay home/buy online trend that was prominent for most of 2020 and 2021. Fast forward six months and that trend has reversed. On May 5, 2022, during one of the biggest down days in the stock market in years, online auto retailers led the way down with Carvana down the most, -15% at one point. On May 11, the company announced (via Zoom) that it was terminating 2,500 employees, or about 12% of the workforce blaming a recession in auto sales. The stock plunged another $6.66 (-18%), resulting in a 87% price reduction since the start of 2022.

Looking at the 5-year price chart for CVNA, the downward trend becomes obvious, and with short interest at more than 30%, the prospect for a sustained improvement in the market price is not optimistic.

Carvana 5-year price chart

Carvana 5-year price chart (Seeking Alpha)

The Quant ratings for CVNA indicate a Strong Sell signal. Taking a look at some of the Factor grades it becomes apparent why the stock should be sold now, before it drops further.

CVNA Quant factor grades

CVNA Quant factor grades (Seeking Alpha)

Post-Pandemic Car Buying Trends

The first quarter earnings season has highlighted the difficulties that auto retailers are facing. The impacts of rising inflation, delays in new car production due to chip shortages, and macroeconomic headwinds are all contributing to the slowdown in both new and used car sales once again.

While Carvana (CVNA) has a host of problems that are specific to its own story, the broad, macroeconomic headwinds that it blamed for disappointing earnings results do appear to be impacting stocks across the sector, perhaps disproportionately to their respective performance.

First and foremost, inflation issues that threaten to slow down demand are cited frequently in analyst assessments of the sector. For example, even after a solid earnings report that beat on top and bottom lines, AutoNation (AN) slid due to margin pressures that Wells Fargo analyst Colin Langan pinpointed.

One trend that is continuing to show promise this year is the buying and selling of used cars. AutoNation has leveraged that trend to boost their revenues by sourcing over 90% of used car sales directly from consumers. During the first quarter of 2022, YOY revenues from used car sales increased 47%.

Q122 Earnings Presentation

Q122 Earnings Presentation (AutoNation)

In fact, during the Q122 earnings call, CEO Mike Manley addressed the progress that AN has made with respect to self-sourcing pre-owned vehicles:

And as I’ve mentioned before, nearly all of our pre-owned vehicles retailed to self-source, which includes our growing We’ll Buy Your Car channel, which purchases directly from consumers, and when I look back at the first quarter we self-sourced 94% of our pre-owned vehicles that we acquired.

How Does AutoNation Make a Profit?

The revenues for AN come from primarily new and used vehicles sales (about 80% combined) and the remainder from Finance and Insurance, and Parts and Service. In FY 2021, the F&I segment accounted for just 5% of revenues but 28% of the gross profit. Thus, any improvements that can be made to generate additional revenues from finance and insurance offerings will help accelerate earnings growth.

Likewise, the Parts and Service segment was responsible for 14% of total revenues but provided 34% of the gross profits. By leveraging the after-sales offerings to customers that purchase vehicles from AN, there is an opportunity to create more higher margin sales in that segment.

Q122 Earnings Presentation

Q122 Earnings Presentation (AutoNation)

With the delays in production of new vehicles, supply chain constraints continuing, and rising prices for everything including vehicles in particular, the demand for parts and service continues to increase. Inventory shortages of new cars due to supply chain disruptions, chip shortages, and production snarls due to lack of qualified labor and parts delivery delays, as well as a lack of used inventory due to people keeping their cars longer, has exacerbated the supply side. The inflation outlook for cars is bad and getting worse according to this article in the NY Times.

Rapid Car Inflation

Rapid Car Inflation (NY Times)

On the flip side, the changing trend to fewer sales has driven the profit margins more to the parts and services segment of the business for AN. Then, presumably as the supply chain issues get sorted out and vehicle production gets back on course, the inventory reductions will begin to resolve about the time the old clunkers die on the road. Meanwhile, used cars become more valuable again as fewer trade-ins are taking place, and used car owners are spending more to keep them in good running condition.

Finance and insurance profits are likely to see a slowdown along with the reduction in new car sales, so that is one trend to watch in the coming quarter. When the trend will reverse and new car sales start to increase again is anyone’s guess.

AutoNation Rolling Across the USA

One reason why I believe that AutoNation offers a distinct advantage over online only retailers is due to the physical store locations. In addition to offering car buyers the opportunity to see and test drive cars before they buy them, it also offers a post-sales opportunity to provide parts and services to those vehicle owners that an online presence does not provide. By rolling out new store locations, it allows the company to expand their geographic footprint which gives them greater access to pre-owned vehicle inventory and gain market share over their competitors. According to the Q122 earnings report, there are plans to complete 12 new store locations over the next 12 months.

Over the past 5 years, like Carvana, AN stock has performed well, increasing over 200% in price.

AN 5-year price chart

AN 5-year price chart (Seeking Alpha)

Unlike Carvana, the price trend is continuing upward, and at a forward P/E of only 5.33 according to Seeking Alpha, the stock appears to be under-valued at the current price of $123.68 as of market close on 5/13/22.

Q1 2022 Earnings Results

On April 21, 2022 AN reported results for the first quarter and those results were surprisingly good. Total revenue was $6.8B, an increase of 14% compared to the year ago period. Gross profit of $1.3B increased 27% YOY. After-sales gross profit was $461 million, an increase of 19% from the year ago period. After sales revenues from parts, maintenance service, and repairs, are higher margin than sales, so those increases add more to the bottom line.

– First quarter 2022 GAAP EPS was $5.78, an increase of 103% compared to first quarter 2021 GAAP EPS of $2.85, and an increase of 107% compared to first quarter 2021 adjusted EPS of $2.79

– First quarter 2022 revenue was $6.8 billion, an increase of 14%, driven by an increase in Used vehicle revenue of 47%, each as compared to the same period a year ago

– First quarter 2022 operating income increased 54% as compared to the same period a year ago

– First quarter 2022 After-Sales gross profit was $461 million, an increase of 19% compared to the same period a year ago

– During the first quarter of 2022, AutoNation repurchased 3.5 million shares of common stock for an aggregate purchase price of $381 million

The used vehicle growth strategy that includes expansion of existing facilities, improved data mining and analytics, and superior used vehicle sourcing from the geographic expansion of AN stores across the country, led to a 47% revenue increase and an 11% increase in unit sales of used vehicles compared to the prior year period. During the quarter the company focused on improving their use of data and analytics and intend to continue doing so to improve decision-making as described by CEO Mike Manley in the earnings call.

Now during the quarter, we sharpened our analytic capabilities, which are increasingly educating our buying, placement and pricing decisions in the used market. And these disciplines are work in progress, but I think you can clearly see they’re going to have a beneficial impact on our business. For example, during the quarter, we recognized the need to rebalance some of our used vehicle inventory to help improve turn and margin. And as a result, in the quarter, we saw a temporary reduction in used margin per unit sold. But because of these actions, as we enter the second quarter, margin return have already improved.

What is in Store for the Future?

AutoNation is building a reputation for premium dealerships with the JD Power recognition and brand recognition derived from their extensive and growing network of used car store locations. They plan to add 130 locations by the year 2026. During the earnings call one analyst, John Murphy, asked a question about the 130 number.

John Murphy

30:49 And then just lastly on the AutoNation USA stores, 130 by 2026. I mean you’re making good progress there. It seems like the business is working well. Why is 130 the right number? Could it be significantly higher?

Mike Manley

31:05 Yeah. I think when the 130 was done, it was really looking at two things: one was which are the most attractive markets that we are not necessarily in with our existing footprint. And by that, I’m talking about franchise business as well. And then the second thing was, as the group is thinking about is capital allocation, what would be a reasonable allocation of capital over that period. I can tell you that our thoughts on that have continued to mature, partly because as they were putting — and we — now obviously we’re putting in AutoNation USA stores, the model was being tweaked and made more efficient. And so today’s AutoNation USA stores are slightly different than the past.

31:42 And secondly, I also think about these stores not just purely as a place where used cars are sold. These stores in the future can do many other things for us. So that 130 is our baseline today. It may well grow, and we may get more aggressive for other reasons.

Whether or not the focus on physical store locations is a better strategy for AutoNation in the future, versus an online retailer like Carvana, remains to be seen. But that strategy, along with an increased emphasis on technology to mine their customer data and to use more analytical decision-making, definitely appears to be working for them, through the first quarter of 2022.

Risky Business

The auto retail industry is a bit cyclical in nature and has been especially so in the last couple of years with the substantial impact of the Covid pandemic taking its toll. But the industry seems to be generally on the road to recovery in the US at least, despite continuing inflationary pressures, the enduring war in Ukraine, Shanghai slowdowns due to Covid lockdowns and shipping bottlenecks, higher energy prices, and other macroeconomic headwinds. Any one of those issues could lead to another recession and AN may suffer because of fewer customers buying new, or even servicing their existing vehicles.

The ability to research and buy cars online is not likely to go away any time soon, but I do not believe that it will take away significant market share from the physical auto dealers like AN, who have adequate geographic coverage in larger metropolitan areas. The perceived risk to the consumer of a strictly online transaction is higher than one where a personal interaction is preferred.

In the case of car buying, many people are accustomed to negotiating in person with a salesperson, not to mention the ability to see and touch the car before making the decision to buy. Some dealerships may become showrooms for online retailers, but then those cars will still need to be serviced and maintained. By combining the pre-sale and post-sale offerings, AutoNation offers a business model that is likely to continue to do well as long as people are still buying and selling cars.

In conclusion, my opinion is that AN is currently a Buy and Carvana is a Sell. I appreciate any comments or suggestions to support or dispute my assessment.


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