Auto Retail Earnings In Depth: Asbury, Lithia, AutoNation and Monro

Throughout my career as an automotive retailer, I've appreciated a challenging market. Because it provides the opportunity for the best operators to rise to the top. More specifically, General Managers that focus on people and processes are able to deliver results in all economic environments.

Source: Charles Oglesby, CEO Asbury Automotive (ABG), July 26, 2007 (2Q07 earnings call)

As we have previously stated, challenging business conditions create opportunities for us to grow through attractively priced acquisitions. Given the current environment, we see several opportunities in our pipeline and expect to announce at least one additional acquisition by the end of the third quarter. Further, we remain confident in our market position and look forward to solid sales and earnings growth through the remainder of the year.

Source: Robert Gross, CEO, Monro Muffler & Brake (MNRO), July 26, 2007 (1Q08 earnings release)

Per store facility snapshot 2Q07

First, let me just give you a quick snapshot of a few key store/facility metrics of the companies that reported Thursday.     

Metric	Asbury	AutoNation	Lithia	LKQ	Monro
Revenue per store	$17,119,693	$18,310,442	$8,195,454	$1,794,446	$154,629
Gross profit per store	$2,641,045	$2,914,458	$1,373,259	$808,331	$67,065
Operating income per store	$607,261	$742,169	$287,778	$204,938	$20,174
Tax rate	37.3%	37.3%	39.7%	43.0%	37.5%
Net income per store	$240,523	$310,442	$73,546	$107,815	$11,756
Total assets per store	N/A	$33,945,382	$16,176,870	$4,969,762	$481,424
Total stores	88	249	108	130	696

Source: company reports, efficient insights llc

Per store (facility) change from 2Q06 quarterly results

 
And below are the percent changes in revenues per store, gross profit (etc.), these companies generated in 2Q07 versus 2Q6. 

Keep in mind with the large public dealers, discontinued operations make the 2Q06 figures a "best guess" because we don't know the comparable stores or assets.  And for Monro, we are not talking about "calendar year" second quarter 2007 and 2006, but instead their first fiscal (financial) quarter ending in June. 

Metric	Asbury	AutoNation	Lithia	LKQ	Monro
Revenue per store	+0.5%	-1.2%	-0.8%	-8.0%	+10.1%
Gross profit per store	+2.6%	-1.5%	-2.3%	-8.3%	+14.6%
Operating income per store	+3.0%	-7.6%	-12.2%	-0.5%	+23.8%
Tax rate	N/A	N/A	N/A	N/A	N/A
Net income per store	+8.4%	-13.6%	-41.1%	-7.5%	+9.0%
Total assets per store	N/A	+2.4%	-9.8%	-7.5%	+6.9%
Total stores	0.0%	-5.7%	+11.3%	+30%	-0.7%

Source: company reports, efficient insights llc

*AutoNation 2Q06 excluded $21 million in one-time expense associated with debt repurchase. 

**Lithia's interest rate swaps did not qualify for hedge accounting in 2006, which had the effect of increasing second quarter earnings by $665,000 after tax.  If you adjust for this accounting change, Lithia's after tax net income per store fell 37.7% on a comparable basis

When the world stops making sense

Right now things should look pretty bleak.  Heck, "Jerry is a great contra indicator" you might be thinking to yourself.  "He gets too deep into the industry."  "He's good for the macros, but can't pick a stock to save his life." 

And in this type of market you would be absolutely correct. 

I can only tell you that while the valuations are not as excessive as what we saw in 1999/2000, the "feel" is very similar. 

Here is what tends to occur toward the top.  Small cap value moves out of favor, and large cap growth and technology moves into favor.  Investor's usual reluctance (aversion) to risk seems to disappear (because things have been so good for so long).  And ultimately investors end up "chasing growth."  

Does any of this seem familiar?

Asbury's stock price performance as of late despite "whistling past the graveyard" should ring home that even companies in the space putting up good numbers are "out of favor" in the investment community. 

Eventually, a hiccup occurs.  Reason returns.  And you tend to see abnormally high returns from those companies that were once so unpopular.  This especially tends to hold true with franchised dealers as interest rates head lower and their depressed earnings make for great "early cycle recovery plays." 

In 2001, the peer group of franchised auto retailers were up nearly 180%.  And even after a ~25% correction in 2002, they went up another 70%+ in 2003. 

Now you could try to be slick and catch the cycles correctly.  But that is a tight rope I don't think people should try to walk (buying and selling investments in the hopes of pushing it off on "the bigger fool.") 

As I have said before, I don't care how good you are at planning for business or the economy at large.  No society will ever perfectly match up the wants and needs of a community with its available resources.  There are invariably imbalances (ebbs and flows, booms/busts in the economy, etc). 

But if we deploy our resources toward those areas that do the best job of finding a need and filling it, I think we stand the best chance of generating the best long term sustainable returns.  Focusing on that (Find a need/Fill a Need) versus getting caught up in the market psychology is admittedly the most challenging, but should also prove the most rewarding over the long run. 

So when the world stops making sense to me (as investors ignore risk/reward), it tends to signal we are closer to the top of the market than the bottom. 

I can only encourage you to not follow the herd off this cliff.    

AutoRetailStocks Index Earnings Yield Summary

Company	Current Year Estimates	Next Year Estimates
Lithia*	8.5%	11.7%
Group 1	11.1%	12.4%
Asbury	10.1%	11.2%
Sonic	10.0%	11.1%
Pep Boys	2.1%	3.1%
Penske Automotive	7.9%	8.9%
Genuine Parts	6.3%	6.9%
Keystone	4.6%	5.4%
O'Reilly Auto	5.2%	6.1%
Midas	4.8%	5.2%
LKQ Corp.	3.6%	4.5%
Monro	5.7%	6.8%
America's Car-Mart	5.6%	8.2%
CarMax	4.6%	5.5%
AutoNation	8.4%	9.3%
AutoZone	6.7%	7.5%
Advance Auto Parts	6.9%	8.0%
CSK Auto	7.4%	N/A
Hertz	3.7%	5.9%
Copart	5.0%	5.5%

Source: Yahoo Finance, Zack's, company reports, efficient insights

*Lithia current year earnings based on mid-point of recent guidance.  Next year based on Zack's consensus of analyst forecasts.

Becoming more critical/helpful
Having said that, sitting in denial that I have not made mistakes over the past year and half would be irresponsible.  Continuous improvement through good times and bad is always the goal.  So you should expect a similar type email now and again talking about ways I plan to improve even when (if?) my top rated stocks are performing really well.

I see my mistakes as two fold: #1, failing to assess management teams appropriately, and #2: failing to do my part in helping good management teams get better.

I have little concern for removing companies from the rankings as the stock prices appreciated.  And I have little concern for moving underperforming "dogs" up the rankings as their investment merits (risk/reward) improved. 

And while I feel a responsibility to educate investors, at the end of the day I don't let the market define me (saying well, if the stock went up or down and I thought the opposite, I must be wrong).  Because real returns eventually work themselves out in the market. 

So as I look back by the way I judge mistakes, AutoNation (AN) clearly ranks at the top.  Because AutoNation is a case where I had confidence in a management team that I should not have had said confidence.

Thankfully, I recognized it pretty quickly after a key member of management departed. 

The other mistake I have made is playing the part of cheerleader versus critic.

I don't work in the brokerage industry any more. I don't need you to buy or sell a stock to make a living (heck I give everything away for free anyway and refuse any compensation from public companies or investors except maybe a free meal now and again if a senior management team or friend in the investment community wants some free consulting). 

So I should leave a lot more of the "making the case" (cheerleading function) for the investment up to you.  I only want to give you the best insights (understanding) about the auto retail companies and the industry at large so that you can make the best resource allocation decision. 

Sure everyone enjoys a kudos now and again.  And I plan to continue pointing out when I think a management team is doing something right (because that goes toward greater understanding too). 

But I think I need to become even more critical of management teams (and even board of directors) when I think they are doing something wrong.  And even more importantly, emphasize areas where management/the board can improve shareholder returns.  Because anyone can point out the problems, but what investors and management teams really need are solutions.      

This (critical/helpful) approach will be my goal over the coming 12-months.  And in this spirit, I have dedicated the majority of my comments this morning to helping investors and management teams see areas where shareholder returns could and should improve. 

 

Lithia Management (LAD) has let down shareholders. They need to adopt L3.
On Thursday evening, Lithia Motors (my top pick) reported yet another disappointing quarter. 

Management can blame the economic environment all they want.  But the fact of the matter is that their newly revised 2007 earnings guidance of $1.60 to $180 per share is eerily similar to the $1.74 in earnings per share the company generated in 2000. 

So I am hardly concerned with a bad quarter, or even a bad year.

And you may recall my rankings piece a few weeks ago that showed between 2000 to 2006, for the most part, Lithia's per store and per employee productivity metrics have either gotten worse, or underperformed most of the other large public dealers.   

No one expects great performance in a difficult environment.  In fact, it is the impending (current?) fall in industry volumes and profitability in the auto retail sector that leaves me so encouraged with leading auto retailer's prospects.   

My theory has been that as the industry turned down, Lithia's superior systems and processes would allow the company to cope better.  Allowing the company to scoop up some serious share as marginal competitors were washed out of the industry.

Remember, I expected the usual tug of war to continue for the next couple years.  And then sometime around 2009 - 2011, as either the union negotiations allowed for plant capacity rationalization, or an economic event (possible bankruptcy by a major automaker) forced said industry rationalization. 

But eventually, the idea of creating demand (at uneconomical returns) would go by the wayside.  And as this happened, it would create a serious strain on an over dealered body, pushing less efficient players out of the market.  

In this tug of war, this is the year that is supposed to favor dealers (as inventories come down).  But the wildcard I have said is with Ford (F) and GM's (GM) employee buyout packages now complete, maybe the era of "demand creation" is ending sooner than anticipated.  Because for once we are starting to see inventories and new vehicle sales volumes come down.     

I don't know how to completely read the results so far this summer (as Asbury's earnings were pretty darn encouraging).  But I am starting to think that the "wash out" of marginal players may be happening sooner than anticipated.  

And if it is happening faster than I expected, you might see the stocks "work" by 2010.  Whereas I thought it might take until closer to 2012 for the world to understand that there was a method to my madness.    

Lithia was supposed to be one of the companies that weathered the downturn better than most because of all of the investments they have supposedly made over the years in superior systems and processes. 

Instead, the company's performance (versus its peers) continues to deteriorate. 

This is where the concern lies.  Not in a structural downturn that I have been saying would eventually prove to be the spark that sets off a wave of market share rationalization. 

And the idea of L2 is like rubbing salt into an open wound to shareholders as CEO Sid DeBoer gets on the conference calls and talks about how they can do things with L2 that they could not do with franchised stores. 

I always felt all of the large dealer groups were trying to get to the same place. 

CarMax didn't want to be encumbered by the existing culture of the franchised model, so they went the used vehicle route, which I think allowed them to get better systems and processes faster.  But in doing so, they gave up some really important benefits (like the dedicated brand service and parts business). 

Lithia (and the other large public dealer groups), on the other hand (I thought), have been working backwords to put superior systems and processes into the franchise model while retaining the benefits of the franchised model (like service and parts). 

With L2, it almost seems like Lithia has conceded they can never get the culture of the franchised auto retail model to change.  And so those of us that believed in all of the systems and processes the company said it was developing were wrong. 

And now it almost seems like management is saying: "Even though it seems like dozens of other companies have tried and failed to copy CarMax (and CarMax itself nearly busted in the beginning), and even though we failed to deliver what we said we would over the last 7 years, in 5 - 10 years time, this L2 concept will work."

Starting to see why shareholders are so frustrated?

And these are the arguments/concerns I laid out to Lithia's CEO Sid DeBoer Thursday night. 

You're a really good debater, Jerry
Source: Sid DeBoer

It paid my way through college.
Source: Jerry Marks

Yes, I am laying it on pretty thick.  And it should be noted that when you look at Lithia's performance (by brand), I suspect you would find that the company's stores are some of the most efficient and profitable in America. 

Only the company made the strategic mistake to let its value acquisition strategy leave it overweight domestic stores.  An approach, admittedly, I supported. 

But Sid DeBoer did not shy away from my concerns.  He refuted what he could, and looked to my input on how they could improve. 

It reminded me of the "debates" I would have with Asbury's former CEO Ken Gilman.  "Why do you exist if you are decentralized?" I would ask him.  "You really need to become more integrated," I would say and write.  "Never say never, but I just don't see the benefits right now of a common dealer management system."  Ken Gilman once said to me as we rolled down Park Avenue during the 2004 New York Auto Show. 

But Ken never came across as someone with all the answers.  He constantly solicited feedback (at least whenever I engaged him), and I suspect he did this even 10x more with his employees and vendors. 

And over the years what evolved at Asbury was a highly admirable approach of integrating non customer facing aspects of the business to become more efficient (like the dealer management system), while at the same time preserving the "entrepreneurial spirit" of the dealerships sales force.  A concept best articulated by Group 1's CEO Earl Hesterberg at the Detroit Auto Show last year.   

In the same regard, Sid DeBoer invites contrary opinion.  And I suspect right now he is looking for a lot of that with existing employees.  Bryan DeBoer (Chief Operating Officer) and Jeff DeBoer [CFO] also both seem to share this trait as well.   

I don't want to follow a company blindly, or get caught in a value trap.  But I just see too much opportunity with Lithia down the road.  And I do have a lot of respect for management.  I just think folks like myself let them get off track (waving the pom pons versus being the critics we truly should have been).

So I need to be very clear: I am very disappointed in management. 

But being disappointed does not do a lot of good.  What the company needs right now is focus and direction. 

So below I have laid out a three point turnaround plan that I hope management and the board of directors consider adopting.  I call it "L3."

#1: An ROI leader. The first thing I want management to do is to conduct a nationwide search to hire someone with considerable expertise in bringing an ROI (return on investment) focus to Lithia. 

This could be a new CFO, but I don't want people to think I am saying to replace or even demote Jeff DeBoer (the current CFO).  It would be like trying to imagine Sonic Automotive without Greg Young (Sonic's Chief Accounting Officer). 

Greg Young is an incredible leader.  Heck, even when he received an award for all of his hard efforts (filling in while Sonic looked for a CFO), he went up to the podium and spent the entire time talking about his team back in Charlotte.     

Sonic had a great accounting team (led by Greg Young), and great operators.  But they needed David Cosper (former Ford Credit Vice Chairman) for it all to come together. Because David Cosper brought an ROI focus.  As did John Rickel and Earl Hesterberg at Group 1, and Craig Monaghan (former CFO at AutoNation) and even Mike Jackson (current CEO of AutoNation). 

So I wouldn't care if Sonic called Greg Young the Chief Financial Officer and David Cosper the Vice Chairman.  Titles are not important.  Skill set is.  And both bring something valuable to the equation.

And that is what I am getting at with Lithia.  The company needs Jeff DeBoer.  I think he is a great leader.  But they also need someone like a David Cosper, John Rickel, etc., to join their organization and bring a focus on return on investment. So I don't know if Lithia hires someone else and gives that person the title of President.  Or if they promote Jeff DeBoer to President and hire a new CFO.  But in some way, Lithia needs an ROI person.  

It will not be an easy hire, or something Lithia should race into.  A key exec at an automaker could work, but I wouldn't even be opposed to someone from a leading retailer.  The only requirement is that they are proven at bringing an ROI discipline to an organization. 

So over the next 12-months, I hope management considers augmenting its leadership team with an "ROI" leader. 

#2: Net expansion halt (no more than +3%).  As you saw with the 2Q07 metrics, Lithia's net store count grew by more than 11% (2Q07 versus 2Q06).  In 2Q08, I think investors should demand that figure is no more than 3% (including L2). 

In fact, you would not hear a complaint out of me if that figure turned negative.  So I was encouraged to hear management discuss on the call how they are stepping up their efforts to dispose (sell) underperforming stores.   

And along those lines, I know management has a 5-year plan to roll out L2 stores.  And while I discouraged the company from going ahead with it, this is the path the company has chosen. 

But I think it starts to become irresponsible to roll out more stores until the first few have been tested. 

If you talk to the folks at CarMax (KMX), they will tell you one of the biggest problems they ran into was seeing initial success with their first couple stores, and going ahead with a big expansion plan (and then having to pause and modify).  I just don't see how Lithia's management can forge ahead with a growth strategy until they have had a chance to experiment with a few stores.    

At the very least, management should consider some of the new L2 stores be "co integrated" with existing underperforming stores.  CarMax has 7 franchises integrated or co-located with their used superstores.  Why can't Lithia find an underperforming store and essentially "gut the place" (staff and all), and then open up an L2 concept with the existing franchise integrated or co-locate with L2?

#3: Service Center Only Stores.  The domestic automakers are trying to shrink their dealer count.  When I think about the underlying need to be filled (for customers and domestic automakers) in rural markets, it really comes down to brand centric certified repair shops. 

People in rural markets that maybe buy a car once every 4 years can handle a drive into a larger metro market to purchase a new vehicle (heck I think more of the search and eventual transactions are going online anyway).  But what Ford, Chrysler, and GM customers who live in rural markets really need is someone to service (and guarantee the quality and consistency of this service) for a specific brand.  They don't want to have to travel 50 miles for routine maintenance.

Brand specific service centers, especially for late-model vehicles (so under 5-years old), in my opinion, deliver a real value proposition to the automakers (helping to preserve their reputation), and to the customer (as working on the same type of vehicle all day long allows the mechanics to do better work in a shorter time).    

So why can't Lithia lobby the domestic automakers to allow it to create some "Chrysler/GM/Ford, etc." certified repair centers?  It can also serve as a drop point for anyone who buys a vehicle on the internet, or even if someone bought the vehicle at the dealership 50 miles or so away and did not want to have to drive all the way back to pick it up.   

Asbury Automotive Group: patience my friends. Consider a "loan to value" acquisition strategy.
If you want to be impressed, look at Asbury's performance as of late.  Don't worry.  They'll struggle again (at least in terms of relative performance).  Several years ago they were the "black sheep" of the sector while folks like Lithia and AutoNation were the darlings. 

So one could say that some of this is just "catch up."  And I tend to suspect in a few years you will see the "favorites" rotate again. 

But this is a management team I have really come to respect (even post Ken Gilman) over the years, so I hope I will have the courage to stand by them in the tough times (as I am doing with Lithia today). 

My goal, however, with Asbury will be to not wave the pom pons too much during this time.  Instead, I want to be as critical as possible to help management from falling too hard (like we see happening with Lithia). 

So let me raise a serious concern that was prompted by a question on the call last week:

Can you provide a little more insight into your commentary that you will well exceed your acquisition target? Is this a byproduct of seeing some improvement in the acquisition multiples, or are you getting some more confidence in specific regions?
Source: Edward Yruma, JP Morgan, July 26, 2007 (2Q07 earnings call)

We actually, we're pretty comfortable with valuations in the market right now. And the reason that we're comfortable that we'll exceed our goal.  We've felt that we've been a little behind the last couple years. And we're actually finding some good opportunities that fit within our model for the future.
Source: Charles Oglesby, CEO, Asbury, July 26, 2007 (2Q07 earnings call)

Don't be in such a rush to acquire.  You're still making great strides with your integration efforts, why add more headaches to the equation?

Importantly, I suspect things are going to get worse in the industry before they get better.  Selling a franchised car dealership is kind of like selling a house.  You heard the guy down the street got $500,000 for his store (house), so you want to be able to sell your store for that much too.  Who cares if your store (house) can only generate $5,000 in net income (rent) a year (which at a $500,000 purchase price equates to a 1% return on investment).   You want the $500,000. 

Ironically, Rob Gross (CEO of Monro) made similar comments about the "stickiness" of auto repair shop valuations on their quarterly conference call.  But Monro is at a point where they have a superior store model, and now needs to figure out the acquisition game. 

Asbury on the other hand, while I think has made notable strides toward the superior store model concept, remains far from arrival.  So continuing on their current blocking and tackling course seems far more prudent than making a bunch of acquisitions just yet.    

So I rarely encourage management teams to become banks or build cash, but making loans (with an acquisition kicker) could make a lot of strategic sense right now. 

What do I mean by this?  I think Asbury's management should start loaning money to struggling car dealers (at a fixed rate), with the option to buy should they default on the loan. 

It will give struggling car dealers much needed capital while providing Asbury's shareholders with a better return (than parking it in a money market or even returning it to shareholders). 

And if the dealer defaults?  Well, maybe now they own a store they would have bought anyway but at a lower price. 

I did this pretty successfully in real estate over the last few years.  Do you really think I was buying property during the boom?  Heck no.  I rented letting the speculators take the risk on cap rates that did not make sense.  "Jerry's such an idiot, he's missing out on this huge housing boom" people from the outside might have said. 

Remember, I focus on real returns, not in the hopes that down the road I can pass something off to the bigger fool. 

So I loaned out money (at 15% - 18%) to speculators at 65% of the appraised value of the property and figured if the speculator defaulted, I could either live in the property or rent it out for an attractive return on investment. 

Eventually, however, even at 65% "loan to value," it did not make sense (because the prices had just gotten out of hand and they were showing me shacks that someone couldn't pay me to live in, let alone the $250,000 or so they were claiming the property was worth). 

Remember, I don't let the world define me.  So when things don't make sense, I try not to do dumb things (like follow the herd). 

In the same regard, this "loan to value" approach is what Asbury (and any large dealer group trying to generate higher returns) should also consider in this environment. 

Find a dealership you want to buy that is struggling.  Or even better yet, find a General Manager [GM] at a dealership where the principle wants to retire and the GM wants to take it over (but lacks the funds).  Then make a loan at 65% to 80% of the appraised value.   

If the dealership turns or the GM thrives, you have helped them, and your shareholders received an attractive return in the process.  If the dealership does not turn, well, now maybe you own it at 65% - 80% of what you would have bought it for anyway.

AutoNation correction. Management/Board of Directors Concerns
On Thursday morning I raced through all the press releases and made the following statement about AutoNation's results:

But let's face it.  Net income was up 6%, and earnings per share (as they bought back stock) was up 15%. You won't get too many complaints out me for a quarter like that.
Source: Auto Retail Informer July 26, 2007

Many of you were quick to point out to me that last year in the second quarter AutoNation had a $34.5 million pre-tax ($21 million after-tax) expense associated with a one-time debt repurchase. 

So if you adjust for the one-time expense, comparable net income was down 16%, while earnings per share from continuing operations fell ~12%. 

I apologize for the mistake.  It is actually why I waited until today to issue my note (versus Friday). 

"The world is drowning in information, but it is starving for understanding" (I will steal a line from an exec from AutoTrader.com at the NABD). 

While I try to give you my thoughts as expediently as possible, at the forefront of every email I send is the goal of enhancing your understanding.  Clearly I failed in that endeavor Thursday with my comments on AutoNation and I am sorry.  

The company had yet again another bad quarter.  And management wasted investors time giving a housing report and talked very little about why they seem to be underperforming their peers.  Similar to my comments with Lithia, performance versus your peers is what is important. 

CEO Mike Jackson even said that it is not true that the problems in the housing market don't impact vehicle sales.  Fine concede.  Having less of an ability to borrow from artificially inflated home equity values probably does hurt a consumer's ability to buy a car. 

The only reason I try to move people away from the housing excuse is because I think there is a larger structural issue at play.  Specifically the demand creation that has occurred in the market over the last 7+ years that is either, or is about to come to a head. 

So to a certain extent, we are arguing over how to pronounce tomato.  In either case, the outlook for underlying demand in the industry is pretty bleak.  In fact the outlook for the industry itself is pretty bleak.  Get used to it! 

Because it is structural not cyclical
The real opportunity (as I discussed with Lithia) is the ability for leading auto retailers to scoop up massive market share as marginal players exit the market.

And I do not think the current leadership is the right team to deliver this opportunity.  I think I have received more negative comments about AutoNation's leadership from current and former employees as well as industry participants than all of the other companies in the AutoRetailStocks.com index combined. 

So it was incredibly disappointing to see the Board of Director's extend out management's contract to 2010. 

Aside from Marc Cannon (head of public relations), management seems to have gone out of its way to tell me I am inferior.  And based on many of your comments (in the field), you feel the same way. 

But my personal concerns about AutoNation's leadership aside, I still have to admit, the data tends to work against my case.  Because while the near term performance has been worse than the peer group, longer term the data tends to suggest they have been developing one of the most profitable store models in the entire space.

As you may recall, on July 10, 2007 when I issued my 3Q07 rankings I showed AutoNation's operating income per employee has gone up 50% between 2000 to 2006.  And its operating income per franchise has improved 52% over the same time period.

They simply have done what I asked them to do (make the stores and employees more productive). 

And if they get back on track with the shared services center, there could be a huge lift one day as they are running duplicative costs today. 

I just hope management will take it to heart that along the way, they have seriously burned a lot of people and need to work extra hard to show all stakeholders (employees, manufacturers, shareholder's) they care about them.    

On top of that.  I think the board of directors needs an overhaul.  Well maybe that's a little harsh.  Maybe more like an enhancement.  Specifically, I think they need to add two new members. 

I was encouraged to see them add Kim Goodman to the board (coming from Dell with Information Technology expertise).  But I think having only 8 members is irresponsible and does a disservice to AutoNation's shareholders. 

Management claims that they add people to the board as they find qualified candidates.  I don't think anyone wants to see them rush into adding just any old person.  But the gradual reduction in board members over the last few years appears deliberate. 

And such a small board creates a lot of problems (in my opinion).  First and foremost, it reduces management accountability.  Because if you take Mike Jackson [CEO], Mike Maroone [COO], and William Crowley (from ESL), they alone control 38% of the board seats.  And Robert Gusky is an investor in ESL's fund, so if you include him, they way I define an independent board (outside of ESL members), you are looking at only 50% true independents. 

So I think management needs more independent people to answer to.

And renewing Mike Jackson and Mike Maroone's contract to 2010 is a great example of what happens when you have such a small board.  What committee decided this?  From the best I can tell, it falls into the compensation committee.  Only as of the last proxy filing, Robert Brown, Edward Lampert, and Irene Rosenfeld were on the compensation committee.  But Edward Lampert and Irene Rosenfeld resigned from the board. 

So is Mr. Brown the entire compensation committee?  Did he do all the research to make the recommendation to the board that they should extend the contracts?    

No wonder why you end up with a management team that treats stakeholders so unfairly (in my opinion).  They have no one to answer to!      

Also, as you may recall, last year AutoNation got into trouble (and was technically eligible for delisting from the New York Stock Exchange/NYSE).  The reason?  A board member suddenly resigned, and he was on a key committee that required a certain % of its members be "independent" (according to the NYSE requirements). 

Similar to management succession planning, I think the board of directors needs to have a back up person (that meets the NYSE requirements) for each of these committees.  And I don't think 8 members allow them to do this. 

So I hope the board will add two more members (bringing the total to 10 people). 

I would be happy to send them a list of great candidates.

Monro might need an integration team

Over last couple quarters as the spread between us and the good guys has increased on a sales line and on a performance line, we will continue to get leverage off our business model, which I am having trouble apologizing for a 15% pre-tax improvement this quarter in this environment.

That being said, when we get that leverage and our good competitors are flat, and the weaker smaller guys are running -3% to -5%, you can argue we are going to get the best of both worlds by being able to continue to grow and leverage our business operations off our own fundamentals of running a +6% comp.

And then being able to buy these guys at a very reasonable multiples, bring them into the fold.  And then 12-months later, additionally, see them able to grow our bottom line as well as our top line.
Source: Robert Gross, CEO Monro Muffler & Brake, July 26, 2007

I tend to agree, it is pretty tough to make a management team apologize for 15% pre-tax earnings growth in this environment (or pretty much any environment for that matter).

But management tightened its fiscal 2008 earnings guidance to a range of $1.85 to $1.90 from $1.85 to $1.95 (when they gave guidance last quarter).  And the reason management lowered its guidance was because the improvements they expected to see with their Pro Care acquisition were taking longer than expected (they expect Pro Care to only be $0.05 accretive this year versus their previous plan for it to be $0.10 accretive). 

Now in response to some of the questions about Pro Care, Mr. Gross made some compelling arguments about how the return on investment (of acquiring Pro Care) was far better than opening up 70 new stores.  And how maybe he should have not set the company's initial target so high.  All fair points. 

I certainly will not disagree with him.  The opportunity in the automotive repair space lies in buying not building new stores.  There seems to be plenty of capacity in the market place.  What is needed, however, are repair shops that can bring greater efficiency to the equation.  And I still think Monro is a leader in that regard (along with Tire Kingdom).    

But come on, management has been stumbling with its acquisitions. Pro Care has fallen short of expectations.  And they had to walk from their initial plans to buy Strauss Discount. 

As I listened to the call, Mr. Gross talked about how the lack of progress at Pro Care prompted a change at the Zone manager level at Pro Care, and how they have made some changes to get more direct involvement out of one of Monro's divisional vice president's.  They have even moved some of the pro care stores to best performing Monro Zone managers in hopes those people can work through some of the challenges. 

I've been saying for some time, Monro is shifting from developing a superior store model (which I think Rob Gross did a tremendous job leading) to an acquisition growth company.  And you are seeing some of those "growing pains" as they figure out the acquisition game. 

I am very upset that none of the analysts on the call asked about the procedures and processes management goes through when they acquire a store.  Sure, we know the end result is usually about 600 to 800 basis points in better operating margins as they leverage Monro's information technology, purchasing leverage, and simply better systems and processes. 

But what is the actual integration process? 

It sounds to me like the integration process remains a "work in progress" and is often left to people out in the field. 

As critical as I was of Lithia in my note today, I think most of you know that I am a pretty big fan of Lithia's integration acquisition support teams.  No their teams are not perfect.  But the idea behind it is to have a dedicated group of people who are really familiar with integrating acquired stores. 

So instead of leaving a lot of the integration up to the IT (information technology) folks and people out in the field, I think Monro should create a team dedicated to acquisitions. 

Now it could be a mix of people out in the field (who have been involved with acquisitions before for Monro) as well as corporate personnel who have other "day jobs."  But when Monro acquires someone, on day 1, they should send these same people out, time and again, to implement a defined integration plan. 

And those people should probably stay for a week or two to make sure that the "integration sticks."  Meaning all of the personnel have been trained, reviewed and approved on each of the company's systems and processes.  If they can't do all of the training, review and approval in the first week, extend the close date.  Because I think a successful acquisition should be integrated in the first week or two (versus letting it slowly get melded into the fold). 

Maybe management is doing a lot of this already. Admittedly, I owe them a call post earnings season to understand their integration process better.  But the bottom line is that it seems like somehow management needs to develop a more systematic approach to its acquisitions.