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Morningstar | Expense Control Helps Asbury Post Strong 3Q Despite Incentive Pressure

Asbury Automotive Group reported a strong third quarter with adjusted diluted EPS up 49% year over year to a third-quarter record $2.21, easily beating consensus of $1.88. We are not changing our fair value estimate. We think we are late in the cycle for U.S. auto demand, and our midcycle operating margin including floor-plan interest of 3.5% is in our view a reasonable level, given recent results of about 4.1% in what we view as good times for the industry.

Same-store revenue grew 6%, with new and used vehicles each up 7% and finance and parts contributing low- to mid-single-digit growth. New-vehicle gross profit per unit fell 7% to $1,517 while new-vehicle unit sales rose 10%. Heavy discounting in midline imports such as the Japan Three brands as well as Asbury missing volume target bonuses at its Detroit Three stores caused this result. Management cited intense price competition with the import brands, which we think will continue into 2019. We think management prefers to not chase volume and instead focus on profitability, as it should; however, it said on the call that it has to cut pricing because the competition does, and without discounts Asbury would not get any volume. This is a tough spot to be in, but as one of the largest dealers in the country, Asbury can better withstand price wars than a small dealer with just one or two stores. We asked management if it is interested in increasing domestic store exposure to obtain more balance, and the answer was yes. The company is constantly reviewing possible acquisitions, as all our dealers do, so a tuck-in deal or a large deal can happen at any time.

Asbury also benefited from the nonrepeat of extra executive compensation and health and workers' compensation insurance headwinds in the prior-year quarter, which helped lower SG&A as a percentage of gross profit (including rent by 220 basis points to 67.9%) and raised operating margin including floor-plan interest by 10 basis points to 4.1%.

Buybacks are likely to continue, with $91 million, or 7% of shares, repurchased in 2018 through Oct. 22, because this month the board reset the repurchase authorization to $100 million. Actual buybacks will depend on the M&A environment; we'd prefer to see them happen at a significant discount to our fair value estimate.

Asbury's management is participating at the Management Behind the Moat conference at Morningstar's Chicago office on Nov. 7-8. If you are interested in attending the conference, please contact your sales representative for registration information.