AutoNation on Credit Watch as Credit Agencies Scramble

First the details:
Standard & Poor’s put AutoNation (AN) on credit watch, citing the U.S. economy and falling auto sales. AutoNation ranks No. 1 on the Automotive News list of top 125 U.S. dealership groups selling over 325,000 new vehicles last year.

Currently AutoNation has a BBB- investment grade from S&P, one step above a junk. The credit watch status, issued Friday by New York analyst Nancy Messer, reflects "conditions that could pressure already weak credit measures well into 2009" and "increased uncertainty" about the length of the auto industry’s downturn and U.S. economic woes.

AutoNation’s corporate credit rating dropped to BBB- in April 2006. S&P changed the company’s outlook last November , from “stable” to “negative,” which indicates a one in three chance S&P will lower the credit rating in the future. The decision to put the company on “credit watch” indicates a 50-50 chance S&P will decrease the credit rating after credit rating officials meet with AutoNation executives in the next 90 days to discuss financial plans.

As of June 30, AutoNation had total balance sheet debt of $1.5 billion, not including floorplan debt, the memo said. In the second quarter of 2008, AutoNation reported the number of new vehicles sold in individual dealerships dropped 12.8 percent from the same quarter in 2007, to 73,545 units.

AutoNation has, by far, the industry's best numbers and is solidly profitable. Sure profits have deteriorated (they would be expected to) but this company is by no means at risk of losing money.

This is in the face of large dealerships across the country closing their doors, which will increase AutoNations markets share. The company is opening Mercedes dealerships in Las Vegas, Orlando and a BMW dealership as well.

Why wasn't this action taken in May? In May CEO Mike Jackson said the auto industry had been "turned upside down" by both high gas and contracting credit conditions, yet S&P was silent. Now, for the first time in over a year we have some clarity out there that credit conditions may begin to relax as a result of the Treasury's plan.

What is the worst that happens? What if the S&P does take action and downgrade AutoNation to junk? Does it affect any debt covenants that could cause a liquidity issue? No. None of AutoNation's debt covenants are tied to its debt rating.

Wouldn't it have made more sense for S&P to have taken this action in May, and now that there is a bit of clarity in credit conditions (In May there was absolutely none) upgrade them from "negative" to "stable"? It seems that S&P is about 6 months behind the curve here. Although, if you have been alive in the last year, this ought not be a surprise to anyone.

The bottom line here is the credit agencies are scrambling. They are publicly taking a fair amount of the blame for the current situation we are in and are now going into full "CYA" mode. Rather than looking at companies individually, they are just painting entire industries with the same brush. This action follows similar ones at Ford (F) and GM (GM) and an expected one at Toyota (TM). This is a bit like saying Wells Fargo (WFC) and Washington Mutual (WM) are in the same boat. They clearly aren't. If one looks at Berkshire (BRK.a) Buffett investment #2 CarMax's (KMX) recent results, AutoNation's are still superior.

Aren't we talking about "risk of default" with the ratings anyway? How can they say a company like AutoNation is at a higher risk of default now? The company is very profitable and very cash flow positive. It is without question the cream of the crop in its industry. Think about it this way. If the #1 retailer is at risk of being "junk" then every automaker and every other retailer ought to already be. You can't have #1 rated below those who trail it.

Disclosure: Long AN