EUR 850.00 For Business Accounts Only

Morningstar | Sonic Preannounces Gross Margin Problems in Second-Quarter Results

Sonic Automotive’s stock fell by as much as nearly 11% the morning of July 18 following a disclosure late on July 17 that it will badly miss second-quarter consensus adjusted diluted EPS and is lowering its full-year 2018 adjusted diluted EPS from continuing operations guidance of $2.21-$2.45 to $1.90 to $2.00. Second-quarter adjusted EPS is now guided to a range of $0.32 to $0.36 versus consensus of $0.49. The company will report full quarterly results on July 27. Management cited significantly lower-than-expected new vehicle gross profit from BMW and Honda stores, which are typically around 40% of store level gross profit, due to less factory incentives to dealers for each brand. This pressure is expected to continue into the third quarter, but management expects new BMW product in the fourth quarter to alleviate headwinds. However, at that time BMW vehicles imported into the U.S. may have a 25% tariff on them, up from 2.5% presently, so consumers may be shunning some high-end BMWs such as the 7-Series. BMW is about 20% of Sonic’s new vehicle revenue each year and Sonic’s largest brand. Honda is second at about 18% of new vehicle revenue.

We are not changing our fair value estimate as incorporating the new 2018 guidance does not move the needle on our valuation. However, we stress that our midcycle operating margin including floorplan interest of 2.5% is generous relative to Sonic’s historical performance. For now, we continue to give Sonic the benefit of the doubt that EchoPark used vehicle stores will eventually become big enough to favorably change the earnings power of the company. If we lowered our midcycle margin to 2.3%, holding all else equal, our fair value estimate would fall to about $18 and at 2% would decline to about $15 holding all else constant.