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Morningstar | Lithia Continues to Grow Earnings Rapidly Via Acquisitions

Lithia Motors' business model is strong because it is the only large publicly traded dealer dedicated to rural markets. These markets are unattractive to the larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Lithia has taken its approach throughout small markets in the Western U.S. The Anchorage, Alaska, area is a good example of the model in action: It has three Chevrolet stores, and Lithia owns two of them plus the only Chevrolet store in Fairbanks. Nationwide, the majority of Lithia brand stores have no competitors within 100 miles. These large market shares in small cities give Lithia pricing power.The October 2014 DCH acquisition transformed Lithia, beginning a strategy of expanding in large metro areas, including the East Coast. DCH's brand mix is heavily weighted to Honda and Toyota with over 30 stores; the company is keeping the DCH brand as well as the nine-store Carbone group in New York and Vermont acquired in 2016 and the eight-store Baierl group in Pittsburgh acquired in 2017. Lithia's management is also retaining its rural market focus, with over 100 Lithia brand stores. The total company store count is nearing 200.Lithia's used-vehicle strategy focuses on what the company calls value autos, boosting gross margins. These are vehicles priced to customers in the $5,000-$10,000 range, generally older than five years, with more than 80,000 miles. The company seeks $2,000 profit on each vehicle regardless of make or age, so value vehicles can have very high margins. We like Lithia's low-risk and potentially high-reward move in September 2018 to invest $54 million to become Shift's largest shareholder. The online used-vehicle startup could prove to be a lucrative investment and gives Lithia access to technology it likely could not have developed on its own.Lithia buys underperforming dealers, rather than unprofitable ones, in smaller geographic markets where one dealer is the leader in a particular car brand. As consolidation continues in the auto dealership industry, we think Lithia will have no shortage of acquisition candidates.