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Should You Invest In Auto Dealers Right Now?

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Auto dealers, as represented by the Zacks Automotive - Retail and Whole Sales industry have had a great run this year, returning 37.8% to investors. As you can see in the chart below, most of the upside was in the first quarter with essentially sideways movement over the past month.

So the big question is, whether these stocks have run their course or whether there’s more upside left in the shares.

It is not an easy answer because this runup in share prices didn’t happen in the ordinary course, but because of the special advantages that auto retailers enjoyed in the face of the great chip shortage.

Since auto manufacturers are dependent on semiconductor components that are in short supply, they are constrained to produce. This is pushing down inventory at auto retailers and allowing them to raise prices, or in some cases, remove discounts that they otherwise couldn’t have. Moreover, because of the limited supply, some people are booking cars and trucks that are not yet on display, possibly because they expect further price hikes.

But while limited supply is a great thing in the short term because of the impact on prices, if the overall impact on volumes is too high, it will still be a pressure on profits. So we need some sort of an indication about when inventories may be expected to come back.

The automakers reporting in the last few days haven’t had good things to say. Ford is cutting Q2 production by 50% and Toyota is halting production at two plants beginning in June that will impact production of 20,000 vehicles. Global consulting firm AlixPartners now expects the chip shortage to reduce vehicle production by 3.9 million units (previous estimate 2.2 million), lowering automakers’ revenue by $110 billion (previous estimate $61 billion).  

For now, nobody knows how long the chip shortage will continue. While some expect it to be a short-term affair, likely to get resolved this year, others are not so optimistic, and see the problem continuing through 2022. Some automakers like Ford are trying to develop workarounds, redesigning their vehicles so they can make use of available components and looking for direct deals with chip companies.

It also makes sense to revisit the original cause of the problem because part of the solution may lie there. What happened in pandemic-hit 2020 was an explosion in demand for personal computing devices to support the at-home economy while auto demand initially took a bit of a hit as people stayed indoors.

So chipmakers diverted production from auto to computing. And now, with the reopening and more people getting back to offices, there may be a moderation in growth of the at-home economy. How quickly chipmakers expand capacity or adjust their operations will play a role in the availability of components for autos. 

So putting it all together, we have a situation where inventory is in short supply for we don’t know how long, which is positive for prices but may not be enough to cover lost sales.

As regards used cars, a number of factors have led to big shortages there as well. One of the biggest sources of used cars are car rental companies that generally sell their cars after using them for 12-18 months. But the pandemic had them cutting their fleets last year without replenishment.

So they aren’t selling now. That’s one. Then there’s the surging demand as vaccinated people have had enough of staying in. And the third reason is what I’ve been discussing so far, i.e. the scarcity of new cars.

Auto dealers do have contingency options for this kind of a situation. Most offer after-sales services that include components and technical staff. Ideally, the aftersales absorption ratio i.e. aftersales profit as a percentage of total overheads, should be in 80-90% range, meaning that if sales fall dramatically, the profit from aftersales services will be sufficient to cover fixed costs. At this time, it’s also useful to know the utilization rate of technical staff (hours worked as a percentage of hours on site), as a higher utilization rate will generate more profits.

But not all dealers provide this information.

So the best option for investors is the estimate revision trend. If companies are beating estimates and analysts are raising estimates for the out quarters, it means that there’s optimism for the rest of the year. Let’s see what we have in this regard-

AutoNation, Inc. (AN - Free Report)

Zacks #1 (Strong Buy) ranked AutoNation, which offers new cars from Toyota, Ford, Honda, General Motors, FCA US, Mercedes-Benz, Nissan, BMW and Volkswagen, used cars, as well as aftermarket services, topped March quarter estimates by 55.0%. More importantly, its 2021 estimates jumped 27.7% over the past month, which is a strong indication of optimism.

Group 1 Automotive, Inc. (GPI - Free Report)

Zacks #1 ranked Group 1, with operations across the U.S., UK and Brazil selling new and used cars and light trucks and providing related financing and insurance, as well as aftersales services, topped March quarter estimates by 26.9%. The Zacks Consensus Estimate for its 2021 earnings is up 7.8%. The company recently raised its quarterly cash dividend by 6.5%.

Penske Automotive Group, Inc. (PAG - Free Report)

Penske’s auto and commercial vehicle, finance, insurance, parts and services dealerships are mainly in the U.S., Canada, Western Europe, Australia and New Zealand. The Zacks Rank #1 company topped March quarter EPS estimates by 24.9% and its 2021 estimate is up 9.2% in the last 30 days. Penske recently raised its quarterly dividend by 2.3%.

Asbury Automotive Group, Inc. (ABG - Free Report)

#2 (Buy) ranked Asbury, which sells new and used cars, finance, insurance, parts and services, beat March quarter expectations by 30.7%. Its 2021 consensus EPS estimate is up 14.4% since.

Rush Enterprises, Inc. (RUSHA - Free Report)

RUSHA is the largest network of Peterbilt heavy-duty truck dealerships in North America and John Deere construction equipment dealerships in Texas and Michigan. It also has aftermarket parts, service and body shop facilities and offers financial services. The #2 ranked company beat the Zacks Consensus Estimate for the March quarter by a whopping 49.1%, after which the 2021 estimate moved up 10.4%.


While analyst estimates do paint a rosy picture, the above factors makes these stocks look a bit risky. However, they could be worth buying if valuations dropped a bit.

Year-to-Date Price Change

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