Investor Takeaways From 2 of America's Largest Dealership Groups

Image source: Getty Images.

When most investors think of the automotive industry, they think of major automakers such as Ford Motor Company and General Motors. And that's fair, but the automotive industry certainly involves much more than that. As more gloom and pessimism surround the industry after a flat July sales result, let's review the recent quarterly results from two of the largest dealership groups, because each gave insights into how they will try to offset slowing sales and provide investors with growth.

What dealership groups offer investors

Investors can extract some good information by looking at the dealership group angle of the automotive industry. While the groups are subject to wild cyclical swings with consumer buying, they possess advantages, too.

One advantage is that dealership groups generate very strong margins with their repair and maintenance bays, which remain less volatile than new and used vehicle sales and help companies stay profitable amid downturns. For instance, during the second quarter, AutoNation's parts and service segment generated gross profit margins of 43% while new vehicles and used vehicles generated 5% and 8%, respectively. And unlike major automakers, dealership groups also aren't tied down to any one particular manufacturer, brand, or segment, which allows it flexibility to adapt to a changing consumer. 

What we learned from AutoNation

AutoNation (AN 0.79%), as America's largest automotive retailer with more than 360 franchises, provides a good look at the auto retailing industry. AutoNation reported all-time record quarterly earnings per share of $1.08 during the second quarter, an 8% jump compared to the prior year. However, what that doesn't tell you is that AutoNation's net income actually declined by 2.7% during the same time period, down to $112 million.

The reason EPS hit a record high while net income actually declined is because of the company's share buyback program. In fact, during the second quarter of 2016 AutoNation repurchased 1 million shares of common stock for a total of $50 million, and it has roughly $116 million remaining on the Board's authorization. Depending on the price of AutoNation stock, that, in theory, could help the company boost its EPS by a couple of percentage points.

Image source: Getty Images.

In a similar scenario, AutoNation's total new-vehicle sales rose 0.5% to more than 85,600 vehicles during the second quarter, but its same-store sales actually dropped 4.5%. That's because AutoNation has been very consistent in recent years in scooping up additional stores, such as completing the previously announced acquisition of four stores in Westchester County, New York in July.

The takeaway from AutoNation is that as new-vehicle sales peak in the U.S. market, growth and shareholder value won't necessarily peak with them, but growth and value is going to come from additional store acquisitions and share buybacks.

What we learned from Sonic Automotive

Another large dealership group, Sonic Automotive (SAH 0.43%), appears at first glance to have done much better during the second quarter. There were headlines emphasizing that Sonic Automotive's net income jumped a staggering 54% during the second quarter to $22.8 million. But if that seems too good to be true, it is, in a way.

Consider that last year's second-quarter net income includes roughly $10 million in impairment charges, which was a one-time deal. So, ignoring some headlines, you'll want to use the adjusted figures, which show Sonic Automotive's adjusted earnings to be $23.4 million during last year's second quarter, and a slightly lesser $23.0 million during this year's second quarter.

Sonic Automotive's new-car sales fell 2.5% on a same-store basis, and its revenue declined 1.7% to $2.38 billion. However, there were some positive aspects in Sonic Automotive's second quarter. Its second-quarter same-store fixed operations revenues were up 3%, and it was able to reduce its SG&A costs to gross by 160 basis points, down to 78.5%.

The takeaway from Sonic Automotive is also pretty simple: To minimize the impact of slowing new-vehicle sales, dealership groups are going to have to minimize SG&A costs and take advantage of their size and scale, compared to the vastly fractured dealership industry. Ultimately, dealership groups, especially groups as large as AutoNation and Sonic Automotive, are going to have to pull multiple levers to deliver year-over-year growth.

What else?

Those levers include the takeaways mentioned above, as well as focusing on more lucrative repairs, maintenance, and parts segments of their dealerships. It also means differentiating yourself from smaller dealerships in a way AutoNation is trying with its online car-buying service that could help consumers buy vehicles from a broader collection of AutoNation stores and have them transferred to a dealership near them. Sonic is making a similar move with Sonic Digital One-Stop that will enable consumers to shop for a vehicle, get a trade appraisal, and complete the purchase without stepping one foot in the store.

These online websites are potential competitive advantages that only large dealerships can afford, and they're advantages only dealerships with many franchises and vehicle inventory can offer -- an advantage that will become increasingly important moving forward.