AutoNation: Lots to Look Forward to Down the Road

| About: AutoNation Inc (AN)

Folks keep asking me about U.S. auto dealers and how much the market is shrinking. Some numbers...

From USA Today: (2/9/09)

Auto sales last year were a paltry 13.2 million, the worst since 1992 and down 18% from 2007. This year, forecasts are 10 million to 10.5 million. The reality: Too many dealers; too few sales.

"The whole goal is to be here a year from now," says Mike Jackson, CEO of AutoNation, (NYSE:AN) the country's largest dealer chain.

The industry will see a net loss of 900 new car dealers this year, the biggest thinning of the ranks in nearly three decades, predicts the National Automobile Dealers Association. That's on top of a net loss of 760 dealers last year.

The numbers alone "don't describe the pain," said the NADA's immediate past president, Annette Sykora, who has Ford and Chrysler dealerships in the small West Texas towns of Slaton and Levelland. Speaking to dealers at the group's convention in New Orleans last month, she added, "Some dealers mortgaged their own homes to try to stay in business and still had to close."

Counting all brands, foreign and domestic, there are about 20,000 new car dealerships in the USA. Consultant Grant Thornton recently estimated the optimal number at about 16,000. At that level, dealers on average should be able to sell as many cars this year as they did 10 years ago — about 750 each.

GM, Ford and Chrysler dealers will bear the brunt of the closings because of the Detroit 3's market share losses. From a high of 8 out of 10 new cars sold in 1984, their market share today hovers around 50%. Weak dealers aren't profitable, aren't able to keep their facilities as clean and modern as competitors' and generally hurt the image of the brands they sell.

State franchise laws generally make it difficult and expensive for an automaker to close or buy out a dealer. So automakers have been letting the recession do the dirty work.

What are the dealer losses looking like?

•General Motors. GM had 6,375 dealers at the start of 2009, down 401 in a year. The goal: 4,700 by the end of 2012. As one of the conditions for its loan, GM promised the government it would drastically slim its business. Hummer and Saab brands are for sale. Saturn could go, too, and Pontiac is to shrink. GM may decide what to do with them this month, said Mark LaNeve, a GM vice president.

•Chrysler. The weakest of the Detroit 3 managed to shed 287 dealers last year to leave it with 3,287 at the start of 2009. It was using a program called Project Genesis, aimed at eliminating overlapping vehicles in Chrysler's lineup and pressuring Chrysler, Dodge and Jeep dealers to consolidate the brands under one roof. This year the program was iced because Chrysler had a bigger need: survival.

•Ford Motor. Ford continues to reduce dealers in metro areas but doesn't have to be as aggressive about it because it didn't accept a government loan. If it had, Ford would have to stick with a formal plan to show that it will become viable, which could include slashing the dealer count. Ford started the year with 3,787 dealers, down 269. CEO Alan Mulally is pinning his hopes on a second-half rally. Ford just tapped its remaining credit line from private sources. If that's not enough, it will have to turn to the government.

•Foreign brands. Most import brands have proportionally fewer dealers and aren't in the same shape as Detroit. Toyota (NYSE:TM), for instance, has about 1,400 dealers, fewer than half as many as Chrysler or Ford, but it outsold both of those automakers last year. On average, a Ford Motor dealer sold roughly 500 vehicles last year, while each of Toyota's averaged more than 1,600.

For a while now I have been saying that while what is happening in the economy is painful now for shareholders of AutoNation (AN), it is setting the company up for dramatic gains down the road. Domestic brands currently make up less than 30% of AutoNation's sales and Jackson has stated his desire to move that to 20%. The business model at AutoNation has them owning the property their dealerships are on. That simply means they can convert a Ford (NYSE:F) or GM (NYSE:GM) dealership to a Toyota (TM) or Honda (NYSE:HMC) easily without any landlord or property owner considerations.

It also means that Jackson is easily able to alter his product mix to capture trends in the marketplace. While AutoNation may be part of the national reduction in GM dealerships for example, that dealership is not sitting idle, it is being converted to a more useful and profitable purpose (different brand).

Here is a "did you know", AutoNation sells 10% of the Mercedes Benz sold in the U.S. (I do not have specifics but I believe its BMW percentage approaches 15%). This is the reason despite "depression conditions" in the auto industry currently, Jackson's company is both cash flow positive and profitable.

When I aksed Mr. Jackson last summer if he would attempt to grow his market share through picking up cheap distressed properties or simply let it grow through attrition, his reply was instant...."through attrition".

The above numbers are showing that those gains are going to be substantial to say the least.

Disclosure: Long AN