Asbury Automotive 1Q07 Results: Future Risks and Rewards

Apr.26.07 | About: Asbury Automotive (ABG)

In the first quarter, Asbury's. . . Florida region. . . delivered 11% year over year bottom line earnings growth.
Mid Atlantic region. . . delivered 17% bottom line growth
South region. . . delivered 15% net income growth
West region. . . saw a 55% increase in the bottom line!

- Charles Oglesby, incoming CEO of Asbury Automotive

Asbury Automotive 1Q07 Earnings (04/26/07)

Who is Asbury?
Asbury Automotive is a franchised car dealer. Like all franchised car dealerships, they sell new and used vehicles. They'll also help you find a bank if you need a loan on a vehicle, or an insurance company if you are looking for something like an extended warranty on the vehicle. And of course, they get a "commission" (to simplify things a bit) for helping to arrange these loans and insurance products offered at the time you buy your vehicle. Finally, when your vehicle breaks down or requires maintenance, once again, Asbury's dealerships are there for you.

So the next time you walk into a Mercedes, Lexus, or Honda/Acura dealership (for example,) it may very well be owned by Asbury. Because they are a really big franchised automobile dealer group. In fact, according the Automotive News survey, Asbury was the sixth largest seller of new vehicles (they sold 104,066 at retail) in the United States in 2006.

Asbury 1Q07 Results: My Bottom Line Impression
Asbury earned $0.45 per share in the first quarter (if I ignore some charges), which was better than my forecast for $0.43 and $0.42 that the nine analysts polled by First Call were looking for. But don't get caught up in the expectations game.

Here's what really matters. If we ignore some charges (I explain further down), Asbury's senior management now thinks they will earn somewhere between $2.20 to $2.28 per share for all of 2007. This is a lot better than the $2.08 I expected with my last published forecast, and similarly better than the $2.12 the nine analysts polled by First Call were expecting. Usually when a management team provides guidance, the analysts' poll (referred to as the consensus) moves to the middle of the guidance range (so $2.24.)

What I expect (and what causes Asbury to be ranked #4) is that Asbury will earn $4.83 in 2012. If achieved, based on yesterday's closing stock price, for every $100 that I invest in Asbury's stock, I should have a claim to $16.50 in annual earnings (so 16.5% "earnings yield.)

I don't know how this stacks up against the other names in the index (because I don't want to get up in day to day price movements in the stocks.) But I can tell you that on Tuesday, I thought Asbury was going to earn $2.08 in 2007, which means they would be 43% of the way toward my $4.83 target in 2012. If management is right about the $2.24 (the midpoint) in 2007, Asbury is now 46% of the way toward my target. This is why the stock went up nearly 4% yesterday.

Also, when you think about the $0.45 the company earned per share in the first quarter, they appear well on pace to achieve the $2.24 (midpoint) target for earnings in 2007. I say this because the $0.45 means they have already made 20% of the $2.24. To put this in perspective, in the first quarter of 2006 they also made about 20% in the first quarter (of what they earned all year.) In the first quarter of 2005, the company only made 17% of what they made all year. And in the first quarter of 2004, the company made 20%.

A little more detail behind Asbury's bottom line results
Asbury said they made $1.4 billion from the vehicles they sold, arranged financing for and fixed for people between January 1st through March 31, 2007 (the first quarter.) If I looked at things on an apples to apples basis, meaning the same stores the company owned in the first quarter of 2007 as the first quarter of 2006, sales were up 3.5% from last year. And after the company paid all expenses associated with these sales (operating expenses, interest on borrowing money and taxes), Asbury made $15.3 million in net profits.

Asbury has about 34 million total shares of stock. And most of these shares can be bought by you or me by calling up a broker or using some discount online broker (probably a better idea) and ordering a share or two. If I divide the $15.3 million by these 34 million shares, it technically means that for every share I buy, I have ownership/claim to $0.45.

Of course, you need to keep in mind that this is merely a "hypothetical" earnings figure. The hypothetical figure pretends the company did not sell any dealerships (continuing operations,) or have to spend $11.1 million in the quarter to refinance a loan, and pay $1.8 million to the company's retiring CEO Ken Gilman.

I'm actually cool with looking at these "hypothetical" earnings figures (for the most part.) I want to know what my future returns will be, and I hardly expect the company (therefore) to spend another $11.1 million to refinance debt (terminate a bond early). Nor do I anticipate compensation being paid out to a retiring CEO every quarter (in this case, I think a well deserved expense). Although I still wish the accountants made all dealership groups to include dealerships they plan to sell in their "continuing operations" until the dealership is actually sold.

In Asbury's case, while they had about $2 million in these "discontinued operations," I was pleased to hear the company's CFO Gordon Smith say on the call that with the sale of a couple "value brands" in the quarter, Asbury has completed its strategic repositioning and therefore one should not anticipate any future divestitures in the near future. In the first quarter, 83 out of the company's 86 stores operated at a profit.

Once again, I don't have a problem with divestitures. Mr. Smith said they constantly review the bottom 10% [an appropriate focus that I think he picked up from his days at General Electric Company (NYSE:GE)]. But I think the accountants should recognize that franchised dealers for the most part do not build, but rather buy, dealerships. As a result, unless we're talking about a really big region or something similar, I think dealership groups are in the buying and selling of dealerships and therefore it is a "continuing operation." Only Group 1's accountants seem to agree with my view on this, however.

Now throughout today, Group 1 Automotive (the 4th largest new vehicle retailer according the AutoNews rankings), AutoNation (the largest new vehicle retailer), and Lithia Motors (ranked #7) will be reporting their results (just like Asbury did yesterday.)

As a result, I think it might be helpful/easier if I wait until tomorrow to show you Asbury's segment performance (new, used, parts and service, etc.,) and some other key metrics side by side these other leading franchised car dealers.

So instead, I wanted to give you some of interesting quotes I jotted down during the conference call . . .

Interesting things heard on Asbury's conference call and the biggest risk over the next six months (Honda Inventory):

Last week we closed on an acquisition of an Acura dealership in Southern Florida (about $40 million in revenues.)

While our model looks for $200 million in annual revenue acquisitions, given the pipeline we're probably looking at $300 million (plus) this year.

25% to 30% of our used vehicle business was subprime. But given our strategy, subprime has increased to 30% to 35% of our business. . . We do not see lenders backing away from subprime. . . subprime auto lending business is more mature, they have gotten the models down, and so fairing better than housing.

We plan on taking a hard look at it [the dividend]. We established a 40% payout ratio. Haven't been to board. You should hear more from us after the second quarter, but we'll probably be in that same 40% payout ratio.

As an aside, a 40% payout ratio from $2.24 earnings would work out to roughly $0.90 per share, about $0.10 better than the $0.80 dividend the company is currently paying.

With Honda and Nissan, we did increase our inventories and this helped drive sales volumes . . . all stores hit the objective, so it resulted in an incremental $700,000. Not all of it drops to the bottom line because of management compensation. But it did help increase Honda gross. Still think having excess inventory is a competitive advantage. Still think some aggressive incentive programs are coming. At this point, not concerned [about inventories in these brands.] In fact, in some markets strategically going after as many Honda Accords as we can.

I will tell you that I have heard comments like this time and again about manufacturer/dealer bonus programs creating a competitive advantage. This causes dealers to feel comfortable building inventories. And yet I can not recall a single time when it actually worked out for the dealer. Invariably, the dealerships find themselves cutting gross margins. And considering Honda represented roughly 26% of Asbury's new vehicle sales in 2006 and Honda's dealer inventories were up 11.5% (year over year) through March 31, 2007, I would say this is a serious concern.

Don't get me wrong; Asbury has defied the odds in many other areas, and maybe they will pull this off. And even if they do get hosed by the manufacturer with too many vehicles, so has every dealer. In my mind, it could simply create a more attractive "earnings yield" if the stock were to hiccup from an event like this. Strategically, I think management continues to do a lot right. Specifically, management focuses on bringing better systems and processes in a "win win" manner to the stores that makes Asbury's employees more productive (and hopefully wealthier).

If you ask me where the risk lies for Asbury, however - at least over the next six months - it is in those Honda inventories.

ABG 1-yr chart:

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