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The roads are quieter these days, and that means leaner times for companies in most segments of the auto industry, including the dealers. However, leaner times are eventually displaced by better times, when profits come rolling in again.
If we were to kick the tires of the two biggest auto dealership groups now, which would be the more promising for future returns?
AutoNation, Inc. (NYSE:AN), based in Fort Lauderdale, Florida, describes itself as the largest auto retailer in the U.S. "As of December 31, 2019, we owned and operated 317 new vehicle franchises from 231 stores located in the United States, predominantly in major metropolitan markets in the Sunbelt region." Roughly three quarters of its revenue comes from the sale of new and used cars, but three quarters of its gross profit comes from parts/service and finance/insurance activities.
Penske Automotive Group, Inc. (NYSE:PAG), based in Bloomfield Hills, Michigan, describes itself this way in its 10-K for 2019: "We believe we are the second largest automotive retailer headquartered in the U.S. as measured by the $20.6 billion in total retail automotive dealership revenue we generated in 2019. As of December 31, 2019, we operated 321 retail automotive franchises, of which 145 franchises are located in the U.S. and 176 franchises are located outside of the U.S."
Both firms are investing in online capabilities, with AutoNation reporting, "Consumers are increasingly shopping for new and used vehicles, automotive repair and maintenance services, and other automotive products and services online and through mobile applications, including through third-party online and mobile sales platforms, with which we compete, that are designed to generate consumer sales leads that are sold to automotive dealers." To back up its efforts, AutoNation made a $50 million minority investment in Vroom, an online car retailer.
The stock price of AutoNation was stronger in the first half of the 2010s, but in the latter half fell back in line with Penske's:
Behind the prices, of course, are data on the fundamentals, which should help us better understand their strengths and weaknesses. To assess which company is the better investment, I will use the Macpherson model, an initial screening process used by Thomas Macpherson of Nintai Investments. It has four criteria: moat, financial strength, profitability and valuation.
To determine whether a company's margins and ultimately its profits are protected from competitors, we first look for a potential economic moat based on having at least 15% return on capital (RAC) and at least 15% return on tangible equity (ROTE). These are the results for the two companies:
The high return on tangible equity suggests these companies have little in the way of intangible assets (including goodwill) in relation to their total tangible equity.
The Macpherson model favors companies with no debt and a GuruFocus financial strength rating of at least 9 out of 10:
Both companies have low financial strength. This chart shows the long-term debt and capital lease obligations for both companies:
The sharp uptick in the Penske graph shows that the company added more than $2 billion in long-term debt and capital lease obligations in 2019.
The GuruFocus profitability rating is based on five different measures:
Operating Margin %
Trend of the Operating Margin % (5-year average). The company with an uptrend profit margin has a higher rank.
Consistency of the profitability
Ideally, a company needs to have a GuruFocus profitability rating of at least 9 out of 10:
Finally, we review the relationship between the companies' intrinsic/fair values and their market prices, looking for a margin of safety as per an earnings-based discounted cash flow model:
Looking at the overall results for all four sets of tests, these two competitors are not much different. Penske has the edge after assessing moats. On financial strength, AutoNation has a modest edge because Penske roughly doubled its long-term debt and obligations last year. For profitability, Penske ranks slightly better, despite having a weaker operating margin and Piotroski score. Finally, on valuation, Penske looks stronger, with a wider margin of safety.
Though these are not major differences, Penske has the edge in three out of four tests.
Ten of the investing legends followed by GuruFocus have holdings in AutoNation. The single biggest holding is that of Edward Lampert (Trades, Portfolio) of RBS Partners, who owned 2.4 million shares at the end of 2019. He was the only guru with more than one million shares.
Penske had only five guru owners at the end of last year. Mario Gabelli (Trades, Portfolio) was the largest holder with just over a half-million shares, while Tom Gayner (Trades, Portfolio) of Market Gayner and Louis Moore Bacon (Trades, Portfolio) of Moore Capital held the second and third largest holdings.
Besides Gabelli, Jim Simons (Trades, Portfolio) is also an owner of both companies, suggesting some of the gurus are splitting their bets between the two.
24.7% of Penske's shares are owned by institutional investors, while 2.26% are held by insiders. For AutoNation, 41.24% of its shares were held by the fund professionals and 1.16% belonged to insiders.
Both companies have been affected seriously by the pandemic and also will be hurt by the economic crisis that is now unfolding.
In a statement on March 30, Penske reported it had taken proactive measures to deal with the financial and operational issues that were emerging. At the time, it had access to liquidity of $1.3 billion, which included $850 million in cash. It also had some $450 million in real estate that was potentially financeable.
After comparing America's two biggest auto dealership groups, Penske appears to me to be a better prospect, but not by a lot.
Based on the Macpherson model, Penske comes out ahead on the fundamentals, but there are areas within each of its categories where AutoNation has the edge. At the end of last year, gurus seemed to have more interest in AutoNation. Perhaps, like Gabelli and Simons, we might split an investment between the two of them.
But, all in all, I'm nowhere near ready to invest in either of them. The discounted prices, especially for Penske, are interesting, but it appears there are better opportunities currently available.
Disclosure: This article is only an introduction to the company and investors must do their own due diligence. I do not own shares in it and do not expect to buy any in the next 72 hours.
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This article first appeared on GuruFocus.