Car dealer stocks: Kick the tires carefully

Booming auto sales don't mean all these names are good buys.

By InvestorPlace Jan 15, 2013 1:26PM
A young man admiring a new car copyright i love images, Cultura, Getty ImagesBy Susan J. Aluise

iplogoAt the Detroit Auto Show this week, automakers and dealers can bask in some good news: Last year was good, and this year could be better if the economy cooperates. 


That means the good times could also keep rolling for publicly traded auto dealers.


But "caveat emptor" is as much an issue with auto stocks as it is with used-car purchases: In a market grappling with excess inventory and hefty incentives, it pays to be choosy.


New cars and light trucks are likely to extend their strong sales run into this year, according to Paul Taylor, chief economist of the National Automobile Dealers Association (NADA). "Pent up demand, affordable auto loans and enticing new-vehicle designs add up to a solid sales year that will outperform the overall U.S. economy," Taylor says.


And when it comes to loans, credit data company TransUnion believes 2013 will be strong for vehicle lending because delinquencies will remain low.


Nevertheless, high dealer inventories and incentives could tarnish these sterling forecasts. Edmunds.com predicts new-vehicle sales growth will slow to single-digit levels in 2013 and used-car prices will fall.


As a result, cutthroat competition for market share among Ford (F), General Motors (GM), Fiat's (FIATY) Chrysler, Toyota (TM) and Honda (HMC) could boost incentives or slim down dealer margins.


That's why choosing wisely among the auto dealer stocks is key. Here are three to drive and three to park now:


Drive

AutoNation (AN). The nation's largest new-vehicle retailer boosted its new-car and light truck sales by 20% in 2012. Imports led the pack with 27% growth during the year. With a top gun CEO in Mike Jackson, the 261-dealership chain in December acquired six locations in Texas representing $575 million in annual revenue.


Its fundamentals aren't bad either: a price-to-earnings growth (PEG) ratio of 0.83 indicates the stock could still be undervalued -- even though share prices are up 36% over the past year. AutoNation's forward price-to-earnings (P/E) ratio of 15 is a little high, but I think the 15% year-over-year quarterly earnings growth makes up for it.


Penske Automotive Group (PAG). The 345-dealer Penske chain, which will report fourth-quarter and full-year earnings on Feb. 13, also delivered strong sales and earnings performance in 2012. In the third quarter alone, foreign brand sales jumped 34% over 2011, when inventory shortages of Japanese vehicles were most pronounced. The chain is facing pricing pressure, but that's partly offset by gross margin growth in parts and service.


I'm intrigued by PAG's new alliance with Hertz (HTZ), announced in September (see PRNewswire story). It's a heads-up expansion into rentals that could pay off big in building relationships with younger consumers, who are less likely than their parents to make big investments in a car. PAG raised its nominal dividend in October, and it has a current yield of 1.7%. The PEG ratio of 0.78 and a forward P/E of less than 13 are also attractive.


Sonic Automotive (SAH). It's hard not to be bullish on SAH after the stock took good care of shareholders in 2012, soaring by more than 80%. I don't think Sonic's boom will go bust in 2013 for several reasons. It has strong, double-digit sales and earnings growth, lower expenses and the lion’s share of its 107 dealerships focus on import and luxury models, providing strong growth opportunities in the near term.


At $1.23 billion, SAH's market cap is only half that of PAG and one-fourth that of AN, but its fundamentals are even better. It has a PEG ratio of just 0.69 and one of the lowest forward P/Es in the sector at 11.3, indicating that the stock could still have something left in the tank. But the 0.40% dividend yield is nothing to get excited about. Overall, SAH has good liquidity, strong management and recently boosted its full-year earnings estimates.


Park

CarMax (KMX). Nothing is wrong with a stock that returned 50% last year. But this is a new year. Used-vehicle prices are expected to slip in 2013 partly because this year will seel 500,000 more lease terminations than last year, Edmunds.com says. Those lower prices likely will stress margins.


Also, KMX’s sales growth is largely attributable to more subprime lending, which could come back to bite the company if the economy turns south. KMX has a PEG ratio of nearly 1.7 and a forward P/E of over 18, which practically screams overvalued in this sector.


KAR Auction Services (KAR). Used cars are also KAR's focus, though in many lower-end segments. Any cascading effect of falling prices could have a considerable impact on KAR's margins. The stock has a PEG ratio of 2.37 and a forward P/E of nearly 18 -- near the top of the sector. That, combined with a lot of recent insider selling, looks like a flashing yellow light.


Copart (CPRT). Copart directly competes with KAR and focuses heavily on the auto salvage sector -- cars and trucks that have been written off as totaled by insurers. The company has Web technology that enables it to hold online auctions with potential buyers around the world. CPRT stores the vehicles until they are sold.


Last month, it got into some hot water with New York State authorities for storing vehicles damaged by Hurricane Sandy near protected drinking water supplies. CPRT faces the same headwinds as other used-car retailers if new-car trends bear out this year. Its PEG ratio of 1.46 and forward P/E of over 17 add to my concern -- as does CEO Jayson Adair's sale of $1.75 million in stock this month, as noted by Barron's.


As of this writing, Susan J. Aluise did not hold a position in any of the aforementioned stocks.


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