My Thoughts On Lithia Motors' Fourth Quarter Earnings

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About: Lithia Motors, Inc. (LAD)
by: Leo Nelissen
Summary

Lithia Motors did beat EPS expectations but suffered from rather weak same-store-sales.

The company's stock and EPS are displaying a massive divergence as traders don't seem to trust the outlook for car dealerships.

I think a (new) car sales recovery is very unlikely as consumer confidence continues to decline while used car values continue to rise.

Auto dealership stocks like Lithia Motors (LAD) have not been easy trades over the past few months. Most are in a downtrend and have not gone anywhere over the past few years while the stock market continued to reach new highs until Q4 of last year. Lithia's fourth quarter earnings did not help either as new car volumes continue to show weakness. All things considered, I am still sticking to the call I made in Q3 last year: stay away.

Source: Lithia Motors

Thoughts On Q4 & Beyond

First of all, fourth quarter adjusted EPS reached $2.57. This is above expectations of $2.42 and 20% higher compared to the prior-year quarter when EPS reached $2.15. Back then, EPS growth was up 16%. Overall, there is no reason to worry based on past EPS growth. Growth is higher than it was back in 2017 - which was a much better year for the US consumer.

Source: Estimize

Sales were up 10% to $2.97 billion. This is $30 million below expectations and $0.27 higher compared to the prior-year quarter. Total same-store used vehicle retail sales were up 10%. Same-store F&I per unit increased 5% to $1,400.

New vehicle unit sales were up just 0.2% while used vehicle retail improved 12.5% to more than 36,000 units. The average selling price of both used and new vehicles showed strong results as both were up more than 4%. Needless to say, the gross margins of used vehicles did much better than new vehicles with used vehicle gross margins dropping just 20 basis points compared to 60 basis points for new vehicles.

Source: Lithia Motors Q4/Earnings Release

Moreover, the average gross profit per unit for used vehicles improved 3.9% to $2,092, while new vehicle average gross profits per unit declined 5.5%.

On a same-store-basis, we see that new vehicle unit sales are much worse. New vehicle retail is down 6.2% to slightly less than 41,000 while used vehicle retail improved 4.9% to 33,003 units. The gross margins divergence also continued to new vehicle retail falling 60 basis points versus a gain of 20 basis points for used vehicle retail.

Source: Lithia Motors Q4/Earnings Release

The reason I highlighted a while back can be seen below. Motor vehicle sales continue to be a big mess despite a recovery in Q4 of 2018. Sales continue to be down roughly 10% after entering negative growth territory in 2015. On a side note, Lithia Motors is trading at Q1 2015 levels at this point.

Anyhow, we also see that used car and truck prices are growing for the first time since 2015. This is not what you want to see when trading a car retailer that is mainly focused on new vehicles like Lithia Motors.

Unfortunately, for investors, it also does not help that the company has stronger key performance indicators than some of its peers as the company highlighted in its Q4 earnings presentation. Revenue growth over the past 5 years has been up 24.2% on a CAGR level while the forward P/E ratio has been at what some might consider to be cheap levels.

Source: Lithia Q4/2018 Earnings Presentation

This valuation has only gotten cheaper as the stock has massively disconnected from the bigger earnings trend as you can see below. If the stock had continued to follow the EPS trend, the stock would be trading roughly $100 higher than it does at this point.

Chart Data by YCharts

Even though this might look like the perfect contrarian trade, I think there is a reason why investors have not yet bought the stock. I am convinced that the current downtrend of sales is a big no-go as it might make EPS growth incredibly hard in 2019. Especially with gross margins starting to deteriorate.

That said, even though I am not putting the stock on my watchlist, I will closely monitor this stock going forward as we might witness some interesting opportunities in case auto sales go positive. The question is whether we first have to deal with even worse car sales in the first half of 2019. Personally, I think traders who are dropping the stock after the most recent earnings are right. I would not like the risks of holding this stock in the midst of a cyclical downturn either. I would not be surprised if the stock were to test the Q4/2018 lows again over the next few months.

One of the reasons why I believe that in addition to everything mentioned in this article so far is the fact that consumer confidence is continuing to drop. I already discussed this in my previous article. Consumer confidence is going from peak growth to growth slowing as you can see below.

Source: University of Michigan

With consumer confidence being in a slowdown, I think a car sales recovery is even less likely.

All things considered, I am very sure we are in for a few very interesting months until the first quarter earnings. I remain on the sidelines and will closely monitor the situation.

Stay tuned!

Thank you for reading my article. Please let me know what you think of my thesis. Your input is highly appreciated!

Disclaimer: This article serves the sole purpose of adding value to the research process. Always take care of your own risk management and asset allocation.

Disclosure: I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.