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Auto Stocks Can Drive Strong Returns This Summer

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As many of us are probably already aware, automakers are seeing significant supply chain constraints at the moment, exacerbated by a chip shortage. As chipmakers hasten to add the required capacity and accommodate auto manufacturers, this situation will continue to improve. However, while most American car makers are building cars without the chips so they can ship quickly as and when the chips arrive, market researchers and company management continue to see some constraints through the end of this year and well into the next.

As a result, auto dealers are well positioned for continued pricing strength, which in turn is strengthening their margins. It’s true that this is a near-term phenomenon and some time next year, we will see the situation normalize. So margins will come down both because of lower pricing and because of additional costs of carrying additional inventory. Important to note in this context is the fact that demand remains very strong and the increased supply will help drive volumes, which will be an offsetting factor for margins.

Net-net, this means that auto dealers are likely to see softer margins and therefore, lower earnings next year than the record-breaking performance this year. But this should not be read as a negative because sales should still continue to climb.

The aftermarket parts business is usually tied to strength in the used-car business. This segment has been quite strong through most of the past year, as fleet owners cut down their fleets and users sought out their own transport. But this was not the only source of strength. Market researchers find that some of the strength was also driven by hobbyists and car enthusiasts who spent more time in their garages for the dual purposes of enhancing their vehicles and maintaining social distancing. Overall, dealers of both autos and auto parts may be expected to see continued strength through the summer travel season although the parts business may be relatively softer.

Additionally, auto dealers have realized that millennials are getting around more these days and they prefer to do things online. So most dealers are building or strengthening their online platforms for research, sales and aftermarket services.

My favorite picks in this segment are auto dealers Asbury Automotive (ABG - Free Report) and Sonic Automotive (SAH - Free Report) .

Asbury Automotive Group, Inc.

Asbury is known as one of the largest automotive retailers in the U.S. The company offers literally everything in the space including new and used vehicles, financing and insurance, vehicle maintenance and repair services, replacement parts as well as service contracts.

The Zacks Rank #1 stock has A grades for value, growth and momentum. ABG beat June quarter estimates by 46.8% and analysts have raised the 2021 estimate by 30.3% and the 2022 estimate by 18.8% within the past month.

Its current five-year plan, implemented a couple of quarters ago has set a target of $20 billion in revenues by 2025. Management expects same store sales growth to add $2 billion, acquisitions to bring another $5 billion and Clicklane, its new online digital ordering platform another $5 billion. The company appears to be operating to plan.  

Sonic Automotive, Inc.

This is another Zacks Rank #1 stock with a triple A for value, growth and momentum.

It is also a leading auto dealer offering pretty much everything that Asbury does. It reported an earnings surprise of 60.4% in the June quarter. And over the past month, its 2021 and 2022 estimates have jumped a respective 27.4% and 15.8%. This is one of those companies that had its estimates rising significantly going into the announcement only to have them rising even further post the announcement.

The company has set a long-term target of more than doubling its total revenues to $25 billion by 2025 while continuing to significantly increase profitability. It is aggressively building out its used car dealership chain called EchoPark Automotive and is on track to reach 25% of the population by the end of the year and 90% of the population by the end of 2025. Management expects this to generate 2 million vehicle sales annually once the network is set up, adding up to a 10% share of the market.

Sonic expects to launch its proprietary digital retail platform in the fourth quarter of 2021, which will also help it meet its long-term target.

Some other #1 ranked auto retailers include Americas CarMart, Inc. (CRMT - Free Report) , AutoNation, Inc. (AN - Free Report) , Group 1 Automotive, Inc. (GPI - Free Report) and Lithia Motors, Inc. (LAD - Free Report) . Practically the whole group is attractive at the moment.

I also like a member of the Automotive - Replacement Parts industry, which is not nearly as hot as the dealerships.

But LKQ Corporation (LKQ - Free Report) is still attractive for a number of reasons. Not only does the Zacks Rank #1 stock have B, A and A grades for value, growth and momentum, but it is also generating strong earnings surprises and resultantly, a positive estimate revisions trend. In the last quarter for instance, it topped analyst expectations by 52.7%. And after such a strong beat, analysts were of course driven to raise their estimates. So the Zacks Consensus Estimates for 2021 and 2022 have jumped 13.0% and 10.6% in the last seven days.

LKQ is one of the leading providers of replacement parts, components and systems for the repair, maintenance and enhancement of vehicles, as well as aftermarket collision and mechanical products. This kind of stock is most likely to do well in an environment where people are traveling more miles.

The pandemic may have driven more people to use their vehicles for leisure outings, but it also took many office goers and other regular travelers off the roads. This was a net negative for the company. But with the great reopening, it now looks like this is both a leisure travel play and a reopening play. And that’s what makes it particularly attractive at this point.

A longer-term driver for this stock is its U.S. and Canada-focused specialty business, which caters to RVs and trucks, as well as other needs like wheels, tires, towing, speed and performance, etc. RVs are a secular growth market, at least in the United States, and the market is particularly strong at this time. Trucking is another segment where many miles are being driven to meet the high demand for various goods.

Although LKQ has not gone unscathed by the chip shortage and other supply chain issues that have taken a toll on transporters and car makers, the scale and range of its products as well as its geographical diversity may be contributing to its current demand strength (it is expected to grow revenue and earnings at double-digit rates this year and follow that up with more revenue and earnings growth the following year).