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Morningstar | Lithia's F&I Helps Drive Strong 3Q

Lithia Motors reported record third-quarter revenue and earnings per share, with adjusted diluted EPS growing 30% year over year to $2.83, easily beating consensus of $2.53. We are not changing our fair value estimate. Total revenue rose 15% while same-store revenue only rose 1%. Share repurchases helped EPS growth as we calculate adjusted EPS of $2.74 using the prior-year quarter's share count. We like that management made the decision to not chase volume bonuses in new-vehicle sales. This decision caused new-vehicle unit volume to fall 5.1% on a same-store basis, but new-vehicle gross profit per unit increased 4.2% to $2,016. This discipline and an impressive 10.5% increase in same-store finance and insurance gross profit per unit to $1,399 helped Lithia's total operating income rise 9.6%. F&I is a major profit center because it includes all commission products such as extended service plans or facilitating a loan. This business is 100% gross margin, so F&I in the third quarter constituted only 4% of revenue but 26% of gross profit. Lithia has made more effort to hire better F&I people and compensate them properly while also expanding its offerings to customers, and the strategy is working well.

Management said it is not seeing any meaningful impact from rising interest rates hurting demand. This makes sense because we calculate on average that a 100-basis-point rise will increase a customer's monthly payment by about $14 while Lithia estimates about $15-$25. These increases, in our view, are not large enough to cause demand to fall hard, and we think we'd have to see a much larger increase for rates alone to affect consumers' willingness to buy a vehicle.

Lithia announced a $250 million increase in the share-repurchase authorization, bringing the total amount to $268 million. The company also said it has repurchased 1.6 million shares, or 6.8% of shares outstanding year to date, with about 946,000 of those shares repurchased since July 25. We like this move because the stock has become undervalued, in our view.