Here's my initial take on Lithia Motors' (NYSE:LAD) results:
There are a lot of moving parts (things to include and exclude) in the results, and I am still following up with management on a few questions. But I wanted to give you my initial take.
I don't think it takes a genius to tell you that Lithia's results were pretty darn disappointing. Sure, I guess if you adjust for a bunch of extraordinary stuff, comparable earnings were roughly $7.9 million, or $0.36 a share. Better than Wall Street expectations (well according to Zack's consensus of analysts estimates) of $0.34.
But I hardly find (even an adjusted up $0.36) a consolation when you consider Lithia earned $11.8 million, or $0.56 in the fourth quarter last year. The good news? Things don't seem to be getting worse. New vehicle gross profit margins (while down 20 basis points year over year) were actually 10 basis points higher. The bad news? Things really should be turning by now. In over half a decade (ok 5+ years) of writing investment research I don't recall Lithia ever being in a "slump" this long.
I've lived through periods where the company has been caught off guard, investing in the future while (frankly) getting hosed by their manufacturing partners to take too much inventory. Let me stop right there and explain something since a number of retail analysts follow this stock. Same-store sales are not very telling in the dealer world. I can give you all of the same-store sales I want if I sacrifice (gross profit) margin. The trick is to gain share without sacrificing profitability (something no dealer seems to have mastered just yet).
So instead, what I have observed year in and year out is that one year a public dealer will emphasize their above industry average same-store sales growth (as gross profit margins erode) and often times overall profits aren't doing too well, while the next year you tend to see below industry average same-store sales, but improving gross profits and often times improving overall profitability. Let me be clear about something. In the dealer world your real revenues start at the gross profit line.
These "sacrificial" profits tend to happen because you were not meeting the manufacturers' market share objectives. And the next year you are able to ease off of these "sacrificial" sales and an often times a leaner and more efficient organization benefits significantly (on the bottom line).
This is about the time I would have expected Lithia's management to ease off these sacrificial sales (on behalf of their manufacturing partners) and begin to focus on having a more profitable store model. Inventories did come down significantly (down some 30 days from where they were last year at the end of December) and so I would have expected the company to begin to turn the corner. And gross profit margins therefore (on a year over year basis) begin to move up, not continue to be down.
Now maybe the timing of all of these retroactive bonus programs (that Lithia seemed to begin walking from this summer) really don't allow the company to show new vehicle gross profit margin improvement until the first half of 2007 (I'm just not sure how those programs have impacted the results).
But if you think I have been too critical of AutoNation's management for not caring enough about their stakeholders, maybe I need to be a little more critical of Lithia for being over accommodating to their manufacturing partners. I think the same could probably also be said for UnitedAuto Group (although up until 4Q06, UnitedAuto Group was able to navigate through the industry downturn pretty darn well). I think the next couple quarters are going to be very telling whether Lithia can snap out of this funk.
LAD: I still see an attractive risk reward
I've raised the issue before. Have I fallen in love with a company and completely missed that something has changed with the model? This is probably one of the greatest challenges for an analyst. To recognize if something has structurally changed at the company and their investment prospects. And yet the answer seems pretty simple to me. No, I don't think anything has structurally changed at Lithia. I think the conference call helped confirm the company remains committed to building a better box.
And a similarly relevant question, why then did I change my view on AutoNation (NYSE:AN) when AutoNation seems to be articulating a similar customer centric vision as Lithia? I think there are two primary differences: 1) I do not see key management departures (AutoNation has lost a lot more than just the company's CFO). In fact my conversations with Lithia's management (throughout its organization) continue to suggest enthusiasm and a real sense of purpose. 2) Lithia is a lot smaller. I'm almost coming to the conclusion that splitting AutoNation up into 4 ($5 billion) companies might be easier in trying to move a rather rigid (entrepreneurial) culture into a more efficient and customer centric business model.
It is Lithia's still relatively small size (I think ranked #9 in Auto News' most recent rankings, smaller than some private dealer groups) that allows the company to be more nimble and experimental. I also think the company's rural market strategy should (and I emphasize should) be more forgiving as the company experiments into what I still think will be a revolutionary way of buying and selling (and servicing) vehicles. Austin Ligon (CarMax's founder) used to say that it took Wal-Mart 20 years before that discount retailer entered metro markets.
Times (for Lithia's shareholders) may seem tough right now for those of us that are used to judging and being judged on a quarterly return basis. And certainly Lithia's management (despite having been public now for nearly a decade) is still learning how to communicate with Wall Street (personally a "feat" I wouldn't mind if they never accomplished).
On the conference call you heard a more reserved Bryan DeBoer (Chief Operating Officer) articulate a revolutionary customer centric and efficient dealership model. But did not want to get into the details as in the past the company they have had to slow/change some of their strategies. Like the vision of a one price used vehicle concept being changed to the assured used vehicle pricing strategy (very limited negotiation).
However, despite rather challenging results. You continue to see the resolve and determination out of management to fundamentally change the way vehicles are sold and serviced. This shift was never expected to be smooth. But I think the company is small enough, nimble enough, and management is committed enough to see it through.
I don't want to put the blinders on. And so I need to be clear. Lithia's results should have been better. And need to get better if they are going to remain a public company (they do have existing stakeholders that similarly have shareholders to answer too). Although executing this strategy as a private company with private equity may not be such a bad idea. But trading only a few dollars above the company's 4Q06 book value (of $25.32 a share) with the potential to create what I think will be a revolutionary way of buying and selling vehicles, (still) seems like a pretty good risk reward in my book.
LAD 1-yr chart: