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Morningstar | AutoNation's New CEO Starts Off With Record 1Q

AutoNation started the era of new CEO and president Carl Liebert on a good note, with first-quarter record diluted earnings per share from continuing operations of $1.02 beating consensus of $0.91. We see no reason to change our fair value estimate. Total revenue fell 5.3% year over year to $4.98 billion and missed consensus of $5.22 billion, while same-store revenue declined 4.7%. An 11% fall in new-vehicle revenue and a 14% fall in new-vehicle unit sales are to blame, but we do not mind the revenue miss. The first quarter's numbers show that management made what we consider a wise decision to chase profit over volume. Dealers can do this because of the highly profitable nature of the parts and service business, which often contributes nearly half of a dealer's total gross profit. AutoNation's variable gross profit, defined as new vehicles, used vehicles, and finance and insurance, fell 1.6% while service gross profit rose 3.5%, which enabled total company gross profit to rise 0.8%. AutoNation did not give its new vehicles away, as revenue per new vehicle sold grew 4.1% and new-vehicle gross profit per unit increased 9.8%. The favorable mix led to selling, general, and administrative expense leverage and a 30-basis-point increase in operating income to 3.8%. We expect continued SG&A improvement from prior restructuring efforts as 2019 unfolds.

Liebert handled his first earnings call well and did not sound like he was struggling to keep up with learning more about the dealer sector and AutoNation, though he did say he is on a "listening journey" as he meets with various stakeholders. He's already met with many store general managers, where Liebert's time at Home Depot should be an asset, as well as all three major rating agencies. Also, we were intrigued that he spent his first week on the job in Silicon Valley with Waymo. AutoNation has an agreement with Waymo to service its autonomous vehicles.

Liebert did not get very specific on his strategic plans, so the fate of the AutoNation USA stand-alone used-vehicle stores is up in the air. Liebert told us on the call that he is willing to be patient on long-term investments but also stressed the importance of showing disciplined execution quarter after quarter, which suggests to us that he will not wait many years for the USA stores to work out like another dealer, Sonic Automotive, has done with its EchoPark used-vehicle stores. Regarding AutoNation's digital platform, he did say he wants to move from a .com focus to a mobile focus. We think that's a good idea not only for customer convenience but also more digital tech in the stores may be able to cut down on SG&A via less paper form processing. There are limits to this, however, because of various state regulations, and some automakers still want paper forms for some parts of a transaction.

We expect AutoNation to refinance its debt soon, given that it has two large bond maturities in February 2020 and January 2021 totaling more than $600 million. Management on the call did not tip its hand too much on plans for these bonds beyond stressing the company's investment-grade credit rating, but we think the company should act to extend these maturities in 2019 in case capital markets become more adverse next year.