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If you've heard the recent news about the Big Three American automakers (Ford (NYSE:F), GM (NYSE:GM), Chrysler) increasing the pace of new-hires, then you know that there is a rebirth in the US car industry. The average age of Americans' cars topped 11 years according to CBS News. As cars do get older the consumer has to replace them because in most cases the cost to fix the car is actually more than the car itself is worth. This bodes really well for the car dealers like Lithia Motors (NYSE:LAD) and is the reason why I've been buying shares of it lately, and I'll make a compelling reason for why I will continue to buy it.

Valuation

Currently based on its trailing twelve month P/E ratio LAD is valued very fairly, including the 5.7% tumble it took the day it reported. If you take a look at that one day chart of LAD for the day it reported (20Feb13) it was down 8.7% at one point but kept creeping higher through the day to finish 3% higher than its low of the day. That reversal tells me that investors were selling the news not because they weren't thrilled with the company smashing results out of the park, but because guidance was only in-line with what they were predicting as opposed to upping guidance beyond what the street was predicting. However, those same investors came back later in the afternoon and bought those shares back, essentially telling Lithia, "We apologize".

(click to enlarge)

Now looking at the 1 year forward P/E Lithia seems to be undervalued at a value of 10.75 calculated on a price of 40.32 and consensus analyst earnings estimate of 3.75 as per finviz.com. Taking a conservative approach of assuming a forward P/E value of 15 before I would consider LAD to be fairly valued based on the coming years earnings, I believe LAD can hit a price of 56.25 a share (a 39.5% increase from here).

Taking a different look at valuations based on a 5-year growth estimate against today's P/E value I'd say that LAD is a little bit undervalued at today's price. Currently the 5-year PEG ratio is at 0.92 and shares of LAD would have to go to 44 before I can consider it as being fairly valued based on a 5-year outlook.

Macroeconomic News

With the tax break holiday over and the sequestration cloud looming in a couple of days the entire market looks a little skittish, and looks like we may be making a bit of a correction here. I'd argue that the tax break holiday doesn't really affect the purchase of consumer discretionary items such as automobiles but affects more of the day-to-day purchases. It's the sequestration that I'd argue really affects the consumer discretionary purchases; with government defense employees possibly getting furlough notices at the end of March and actually getting furloughed one day a week that automatically removes 20% of that employee's paycheck. With a bite already taken out of that employee's paycheck before they even see the direct deposit into their account you can very well infer that those employees will attempt to make due with the current automobiles, home appliances, and other big ticket items they already have rather than purchasing a new one for now until clarity about their jobs comes to fruition.

Conclusion

Personally I don't believe the government can reach a deal regarding the sequestration in the next couple of days and that consumer discretionary big ticket purchases will be put on hold. With that said I do believe that Lithia Motors is fairly valued right now and have began a position in the stock, and when the sequestration issues can get resolved (which I believe may be at the end of 2Q2013) you'll begin to see the big ticket items like cars come flying off the lots. Lithia Motors is well positioned to capture gains in car sales as it franchises dealerships representing almost every major automobile company there is, and I particularly believe those gains will come in the second half of 2013. Currently there are 8 analysts that cover the stock, 6 of which rate it a strong buy and the other two rating it a buy. Personally I will look to continue to add to my shares at current levels.

Disclaimer

All data is accurate per finviz.com as of 25Feb13. These are only my opinions; please do your own homework. I'm not responsible for any of the decisions you make, only you are.

Source: Let's Go Car Shopping