Autoretailstocks' Revised Auto Retail Rankings: UAG Now in Elite 5, AutoNation No Longer Ranked

Happy New Year. I hope you enjoyed your holidays. Today marks the first trading day of the New Year. And as usual a new quarter means adjustments to the AutoRetailStocks.com rankings.

While I continue to wonder what you would get out of suing a website or company that doesn’t generate any revenues (maybe a skim board or autoretailstocks.com t-shirt?) my usual caveats apply. In particular, the legal/disclaimers section of the autoretailstocks.com website part that says:

“It is our sincere hope and recommendation that autoretailstocks.com and the AutoRetail Informer be used only as a part of a diversified equity investment strategy. Readers invest at their own risk, profits are not guaranteed and losses are possible.”

I should also point out that since inception (of the rankings priced as of 07/07/06), the elite 5 are up 9%, the top ten are up 8.6%, while the autoretailstock.com index itself is up 16.8%. In other words, you would have been better off buying all of the names in the autoretailstocks.com index, or even the 10 names that were not ranked than buying the elite 5 or top ten. I hardly consider 2 quarters a sufficient time period to judge performance (particularly given my long term approach), but clearly under performing the benchmark should be noted.

Don’t you wish all sell side analysts showed their aggregate performance (of buys and outperforms) versus their entire coverage universe? In other words, do the names they recommend outperform the names they don’t recommend you buy? I think institutions should begin demanding aggregate performance metrics (by analyst) from their sell side vendors.

Noteworthy changes to rankings
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UnitedAuto Group (UAG) moves back into the “elite 5.”

Keystone (KEYS( is bumped out of elite 5, LKQ (LKQX) remains (albeit in a lower slot). I lowered my 2012 earnings estimates for both companies to reflect higher risk in generic parts gaining share from “new” manufactured parts.

Asbury (ABG) (previously unranked) joins the top ten (one slot away from the elite 5).

AutoNation (AN) (previously #6) is removed from the rankings until new leadership emerges.

Lithia Motors (LAD): #1 (unchanged from last quarter)
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Lithia clearly had a difficult 2006, and their guidance/expectations for 2007 don’t seem very encouraging either. Management is guiding for basically flat 2007 earnings per share due to investments and higher insurance and health care costs. I recognize the risks to my 2012 earnings estimates have increased as my forecast for earnings growth continues to get “back ended” (one of the oldest tricks in the book for analysts). Given how tough 2006 was for the company, I can understand management being tentative with their guidance (whenever you go through a rough patch you tend to do so).

But I have lived through too many periods where Lithia had a really bad year followed by a really good year. The additional expenses are real, and investors need to take note of them. However, at some point (be it the 4Q06 or 3Q07) I think Lithia’s trends will change (demonstrating stronger than anticipated earnings growth) as a result of all of the investments they have made into systems and processes. So at this point, I am not ready to lower my 2012 earnings per share estimate of $8.29 Clearly, if the trends do not improve, however, and it really does look like Lithia will finish 2007 with flat earnings, I’ll have to revisit this opinion (my hedge/caveat).

So, given my earnings per share [EPS] estimate of $8.29, I think Lithia will be worth ~$109 in 2012 as the stock trades at a 13.1x price to earnings multiple (based on the company’s 5 year historical median.) If the stock comes any where close to my price target (granted there is always a lot of variability when you are assuming multiples and earnings 5 years from now,) it represents nearly 280% upside from Friday’s closing stock price ($28.76 on 12/29/06).

Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it means Lithia’s shares have a net present value of $74 None of the other companies come anywhere close to offering this much upside potential. And this is why it remains my number one pick. Clearly, it is because investors do not believe Lithia can achieve anywhere near this type of earnings growth. I still think the company’s investments into better systems and processes are going to pay off, and that 2007 could prove the turning point. Only time will tell.

Sonic Automotive (SAH): #2 (unchanged)
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Sonic remains my second favorite stock in the autoretailstocks.com index. I continue to be encouraged with management’s efforts to implement better systems and processes and a more sophisticated approach (ushered in by the company’s new CFO, David Cosper) on improving returns on investment (i.e. better deployment of shareholder capital). I think the people throughout the Sonic organization are first rate. And the addition of Mr. Cosper filled in the missing piece of the puzzle, paving the way for more efficient capital deployment.

As a result, I have edged up my 2012 earnings per share estimate to $6.62 from a previous estimate of $6.47 The progress being made at the company is faster than I anticipated. And while I think investors should always be braced for ebbs and flows (so we should be careful about reacting to a couple quarters of improved performance), I just think we are seeing every sign that the long term prospects for Sonic are getting brighter. Based on this 2012 estimate, I think Sonic will be worth ~$67 in five years from now (sometime in 2012) as the stock trades at 10.1x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents more than 130% upside from Friday’s closing stock price ($29.04 on 12/29/06). Using an 8% discount rate (over the course of the next five years,) based on the 2012 earnings forecast, it comes out to a net present value of $46.

UnitedAuto Group (UAG): #3 (from #7)
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UnitedAuto Group returns to the Elite 5, after getting bumped (due to price) last quarter. I have continually been impressed with UnitedAuto Group’s management team as they skillfully merge investments into both people and processes. So I can’t really say that my opinion has changed with respect to UnitedAuto Group. Instead, the improved ranking for UnitedAuto Group really reflects a weaker outlook for some of the other players and/or price appreciation, leaving the company the third most attractive stock (according to me) in the index. My 2012 estimate is unchanged at $3.44

As I discussed after the company reported 3Q06 results, UnitedAuto Group exceeded my estimate by $0.02 in the quarter despite a rather “choppy” industry environment. I left my 2006 earnings per share estimate unchanged at $1.40, but considering they beat my 3Q06 forecast, this clearly means I have taken a slightly more conservative posture with my outlook for them in 4Q06. No sense in being overly aggressive. I also adjusted my 2007 eps estimate to $1.65 from $1.67 The lower outlook in 2007 reflected a slightly more cautious same-store sales outlook (1.5% from a previous estimate of 2.9%). There is considerable weakness in Europe’s industry results right now, and while UnitedAuto Group has managed well through it, I wanted to leave a little cushion there.

Based on my 2012 earnings forecast, I think UnitedAuto Group will be worth ~$51 in five years from now (sometime in 2012) as the stock trades at 14.9x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents nearly 120% upside from Friday’s closing stock price ($23.57 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $35.

O’Reilly Auto Parts (ORLY): #4 (unchanged)
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O’Reilly holds onto its spot as my fourth favorite auto retail stock in the index. While the industry environment remains difficult, causing me to lower my forecast for 2006 and 2007, I think the company’s leadership role (as a company owned jobber) will allow O’Reilly to gain share in the commercial (repair) automotive aftermarket. In particular, I think O’Reilly is particularly well positioned to evolve into a “franchisor” of repair shops, bringing significant efficiencies to a highly fragmented (extremely entrepreneurial) service repair shop market with their O’Reilly Auto Cares Centers.

So I am leaving my 2012 earnings estimate unchanged at $3.35 Granted, similar to Lithia, I am “back ending” my estimates (meaning I am expecting some “make up” in the out years), creating more risk to the forecast (the further you go out the tougher it is to see the earnings). Something you should take note of. But, like I said, I just think O’Reilly’s “company owned” jobber business model (combined with the O’Reilly Auto Care Centers) over time will afford considerable market share gain opportunities in the commercial automotive aftermarket.

Based on my 2012 earnings forecast, I think O’Reilly will be worth ~$69 in five years from now (sometime in 2012) as the stock trades at 20.6x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents roughly 115% upside from Friday’s closing stock price ($32.06 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $47.

LKQ Corp. (LKQX) Corp: #5 (from #3)
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I have not made any major changes to my near-term (next two year) forecast for LKQ. However, I am lowering my 2012 earnings per share estimate for LKQ to $1.73 from $2.48 There are a couple reasons for such a dramatic revision: #1) as I have discussed throughout the quarter the International Trade Commission [ITC] ruling in favor of Ford (against generic parts distributors) combined with a new lawsuit out of MQVP against Keystone all heighten the risk that generic parts distributors will be able to gain market share (as I expected) in the coming years versus “new OEM” parts.

#2) LKQ had tremendous stock price appreciation in 2006 (up ~33%). As a result, the stock’s median historical price earnings multiple (which is what my multiple target is based on) has risen to ~27X. I know, professional investors will criticize me for using a rather rudimentary valuation approach such as historical P/E multiples (I encourage you to read my consolidated valuation think piece). But as I have discussed in the past, in most cases, I think earnings are the best indicator of returns for these companies (as radical swings in working capital and capital expenditure investments distort the real returns on a cash flow line). I also think using a straight discounted cash flow or economic value add analysis allows for “double subjectivity or risk accounting.” Meaning I make assumptions on both the discount rate (which incorporates risk) as well as the earnings figures. I think if you are going to account for risk, do it in one place (the earnings).

As a result, I have tried to keep subjectivity in the price targets out of the equation. I think taking a 5- year median multiple is as good a guess as anyone’s as to what/how the stock will be valued 5 years from now. And where the real subjectivity then gets applied is what I think the earnings will be. Having said that, when I ranked LKQ this summer, I pointed out that the company does not have a 5-year track record, and so historical multiples for this company are less indicative.

So given growing risk to the earnings combined with a rising price/earnings multiple target (due to the stock’s stellar performance this year), I think it is appropriate to take a more conservative posture with my earnings forecast. Having said that, even with what I consider a rather cautious 2012 earnings forecast, the stock still makes it into the Elite 5. And I continue to think the long-term growth prospects for LKQ are attractive (there’s just an added element of risk).

Based on my 2012 earnings forecast, I think LKQ will be worth ~$47 in five years from now (sometime in 2012) as the stock trades at 27x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents a little more than 100% upside from Friday’s closing stock price ($22.99 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $32.

Asbury Automotive (ABG): #6 (from unranked)
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A company that is long overdue (in my opinion) in joining the rankings is Asbury Automotive. Management has skillfully navigated through this difficult industry environment and proven the naysayers (like myself) that non-automotive (senior management) folks that focus on people development and better processes can generate attractive returns. Even their emphasis on great brands (something I have not been as big a fan of) seems to be paying off well. It “increases their odds of success” as CEO Ken Gilman told me in an email in 2006. I only wish I had included this company in my rankings earlier.

Based on my 2012 earnings forecast of $4.83, I think Asbury will be worth ~$46 in five years from now (sometime in 2012) as the stock trades at 9.6x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents a little less than 100% upside from Friday’s closing stock price ($23.56 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $31.

Group 1 (GPI): #7 (from #8)
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Group 1 is coming up against some pretty difficult earnings (and even hurricane) comparisons, but I think management has done a good job in turning around the company. I remain enthused about the company’s growth prospects.

Based on my 2012 earnings forecast of $7.96, I think Group 1 will be worth ~$96 in five years from now (sometime in 2012) as the stock trades at 12.1x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents more than 85% upside from Friday’s closing stock price ($51.72 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $65.

Keystone (KEYS): #8 (from #5)
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Keystone gets bumped out of the elite 5 and I am lowering my 2012 earnings estimate to $2.66 from $3.65 Keystone didn’t benefit much from multiple expansion like LKQ this year, but unlike LKQ (that has both salvage and generic parts distribution), Keystone has the greatest risk to the recent confrontation with the automakers over the distribution of generic parts (they are all aftermarket products). I should point out the automaker confrontation is not the end of the world and is not an entirely new issue (albeit intensified).

Over the next few weeks I hope to address some of the opportunities I see for Keystone (and LKQ for that matter) as more sophisticated players like Keystone and LKQ implement and ensure higher quality standards of generic parts. But the bottom line is that right now, the risk to earnings has increased, and so I felt compelled to take a more conservative outlook.

Based on my new 2012 earnings forecast, I think Keystone will be worth ~$59 in five years from now (sometime in 2012) as the stock trades at 22x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents ~75% upside from Friday’s closing stock price ($33.99 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $40.

Genuine Parts (GPC): #9 (unchanged from prior ranking)
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I have edged up my 2012 earnings forecast ever so slightly to $5.12 from $4.98 While the company’s automotive segment may remain under competitive pressure as the competitive environment heats up, I am encouraged with the leverage opportunities that exist for the company’s industrial segment. In addition, I really like Genuine Parts entry into the heavy truck side of the business. I think it is a natural compliment to their existing competencies and presents a $15 - $20 billion annual market.

Based on my new 2012 earnings forecast, I think Genuine Parts will be worth ~$83 in five years from now (sometime in 2012) as the stock trades at 16x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents just below 75% upside from Friday’s closing stock price ($47.43 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $56.

Monro Muffler Brake (MNRO): #10 (unchanged from prior ranking)
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My outlook for Monro to earn $2.83 per share in 2012 remains unchanged. While I think independent repair shops in general will be under heavy competition from the franchised auto retailers in the coming years, I believe “low tech” service providers like Monro that focus on a limited service offering stand well positioned to gain share. The company’s comps have been struggling (although more recently recovering). But assuming same-store sales return to a 4% clip by 2009, and the company continues to generate operating expense leverage, you get to my 2012 earnings per share estimate of $2.83.

Based on my 2012 earnings forecast, I think Monro will be worth ~$56 in five years from now (sometime in 2012) as the stock trades at 19.8x my 2012 EPS estimate. If the stock reaches these levels (earnings and multiple), it represents just below 60% upside from Friday’s closing stock price ($35.1 on 12/29/06). Using an 8% discount rate (over the course of the next five years), based on the 2012 earnings forecast, it comes out to a net present value of $38 Like most companies that fall into the #10 slot, I wouldn’t mind a pull back in the stock price before becoming more aggressive with the name.

AutoNation (AN): unranked (from #6)
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As I recently discussed, I think AutoNation is going through a management transition. True, Mr. Jackson (AutoNation’s current CEO) has done an amazing job turning around the company (from its aggregation phase of the late 1990s) and moved it into becoming an operating company. So AutoNation definitely does not need to transition into an operating company (one focused on capturing economies of scale). They clearly are moving in this direction. And Mr. Jackson’s contribution to AutoNation’s shareholders and the industry should not be taken for granted.

But, like most good companies, at some point, a slightly new direction is needed. In this regard, I think the next stage for AutoNation is to become more focused on its stakeholders (vendors, shareholders, employees, customers, etc.). And this may require a different skill set.

Without a permanent Chief Financial Officer (a process that is appropriately taking a while), and my opinion that the entire management team is in transition, the company’s growth prospects become difficult to determine. Once new leadership emerges at the company and a more stakeholder friendly direction is set, I think the stock could become interesting. But until then, I think it is best to error on the side of a missed opportunity. And therefore AutoNation is removed from the rankings.