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Morningstar | AutoNation Has Solid 2Q, and We Like Seeing More Buybacks While Stock Is Cheap

We are not changing our AutoNation fair value estimate after the auto dealer reported good second-quarter results that gave us no reason to change our thesis. Diluted EPS from continuing operations came in at $1.07, up 11% year over year, but was $1.14 excluding a franchise rights impairment charge. AutoNation does not report adjusted EPS like most other dealers, but excluding this charge it would have beaten consensus EPS by a penny. Same-store revenue increased 3.7%, mostly boosted by strong finance and used-vehicle businesses. All dealers had strong used-vehicle demand for the quarter, and AutoNation's same-store used-vehicle retail revenue increased by 8.9% while same-store used-vehicle gross profit per unit grew 14.1% to $1,455. New-vehicle gross profit fell by 9.7%, and new-vehicle gross profit per unit declined by 8.7% to $1,579, with management calling out Nissan, Honda, and BMW for about 70% of the 50-basis-point new-vehicle gross margin compression, to 4.2%. These pressures will continue in 2018 because of fierce competition.

Selling, general, and administrative expenses as a percentage of gross profit improved slightly from the prior year's quarter, declining by 60 basis points to 73.4%, but remains elevated as the company continues to invest in the AutoNation USA stand-alone used-vehicle business, new collision centers, and AutoNation branded parts. Management does not expect to add more USA stores this year but said the business is progressing well and will provide a more detailed update in the third quarter. SG&A to gross profit levels remain elevated relative to the company's normal level in the upper 60% range, but CFO Cheryl Miller expects substantial improvement in the second half of 2018, particularly in the fourth quarter. The improvement comes from normal seasonality of higher premium brand business in the fourth quarter and expected improvement in profits from recently acquired collision centers. AutoNation now has 81 collision centers.

We liked seeing more stock buybacks in the second quarter, because management is repurchasing what we see as an undervalued stock. Second-quarter repurchases totaled $73.4 million at $45.88 a share and totaled $100 million for the first half of 2018 at $47.62 a share, by our math. The current authorization has $264 million remaining, and we expect more buybacks in 2018 as management is reporting no major change in dealers asking prices, so acquisition activity may be minimal while buybacks continue. AutoNation did acquire its 17th BMW store (announced Aug. 1) in Southern California with about $140 million of annualized revenue. It also announced the acquisition of Trade Secret Auto Care, a collision center in Dallas. CEO Mike Jackson said he targets more M&A in the premium space since the service business is attractive.

AutoNation also expanded its relationship with Waymo announced late last year in which AutoNation has nonexclusive rights to service its autonomous vehicles. AutoNation now will offer its Phoenix customers the use of a Waymo while their vehicles are serviced at an AutoNation store. This arrangement in Phoenix is exclusive to AutoNation dealers. Although the move in our view probably does not lead to any meaningful incremental monetization from Waymo, it does give vehicle owners a new reason to choose AutoNation for their service needs. Parts is by far the largest contributor to gross profit. The segment typically has gross margins in the mid-40% range and contributes around 45% of all the firm's gross profit. We see the move as low-risk but high-reward for AutoNation.