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Morningstar | Great Execution by Lithia's Management Leads to a Record 2Q

Lithia reported a record second quarter, but we see nothing to merit changing in our thesis or fair value estimate. We continue to see the company's growth runway as bright, with good balance sheet health and a robust acquisition pipeline. Management talked on the call about U.S. acquisitions being the priority due to so many opportunities, thus we expect Lithia to remain U.S. exclusive for a while. Credit line capacity is $218 million and management estimates its $329 million of unencumbered real estate could provide $247 million of further liquidity, if needed. We don't expect Lithia to use its real estate for this purpose, but the assets are a nice buffer for hard times should capital be needed. Adjusted diluted EPS of $2.95, which excludes $0.32 of charges for weather and acquisition costs, grew 17% year over year and easily beat consensus of $2.81, driving the stock up 12% on July 24. Same-store revenue grew 5.8% and total revenue grew 4% to slightly beat consensus.

The quarter's numbers show a similar pattern we've seen across our dealer coverage; declining new vehicle sales, while used vehicle sales rise. New vehicle gross profit per unit, or GPU, is not plummeting, which means management is not overly discounting its new vehicles to chase volume over profits. Smaller dealers have to chase volume to earn incentives from automakers for meeting volume targets, but firms like Lithia have deeper pockets and better scale and vendor terms across their operations, thus they don't have to play that race to the bottom. We expect the trend of tepid new vehicle demand to continue as off-lease supply is expected to peak this year, which means consumers are seeing much better value and choice in used vehicles than they have in years. Lithia's new vehicle revenue fell 1.1% but new vehicle gross profit per unit grew 0.4% to $2,078. Used vehicle revenue grew 10.5% while used GPU fell by 2.4% to $2,174.

Finance and insurance, which is a 100% gross profit business based on commissions, had a great quarter and helped drive adjusted operating margin to 3.9%, up 20 basis points. Lithia keeps increasing add-on insurance and warranty products, which stores it acquired tended not to prioritize, instead preferring to focus on moving cars off the lot. F&I GPU rose 11.9% to $1,453 and total F&I revenue grew 12.7%. This improvement comes from Lithia's preferring to buy underperforming stores that it feels can be turned around, and the company continues to show it is good at executing this plan.