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Investor Takeaways From the First-Quarter Reports of Sonic Automotive and Lear Corp.

By Daniel Miller – Updated Apr 29, 2017 at 4:41AM

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How are auto industry players responding as U.S. vehicle sales peak? Here are some insights based on the latest earnings reports of a major dealership group and a parts supplier.

The bears continue to pile on the automotive industry as new vehicle sales in North America reach this cycle's peak, but that doesn't necessarily mean the good times are over. This week brought investors a ton of insight from major automakers, top parts suppliers, and some of the nation's largest dealership groups. Here are some insights gleaned from the quarterly reports of Sonic Automotive (SAH -0.10%), Lear Corp. (LEA -1.02%).

Short term pain

Sonic Automotive ranks as the fifth-largest dealership group in the U.S., per Automotive News, but its scale wasn't enough to salvage a tough first quarter. Some of its issues stemmed from decisions that embraced short-term pain in favor of long-term benefits (more on that shortly). Looking at the financial figures, Sonic's total revenues in Q1 inched 2.4% higher to $2.29 billion, thanks to gains in used car revenues that offset a slight decline in new car sales.

The question of how Sonic fared on the bottom line is a little more complicated, depending on which figure investors prefer to consider. Its net income from continuing operations swung to a first-quarter loss of $541,000, compared to the prior year's result of $14.5 million, or $0.31 per share. However, that result includes charges of $15.3 million, ($0.21 per share) related to the redemption of Sonic's 7% senior subordinated notes due 2022, as well as weather-related damage costs and fixed-asset impairments -- but the refinancing of debt should bear fruit down the road.

Row of new cars at a dealership.

Image source: Getty Images.

As CEO Scott Smith said in a press release:

We continue executing strategies that yield long-term benefits. We believe the refinancing of our 7% Notes with a 6.125% Note issuance will prove to be a big win for us as we expect interest rates to continue to gradually rise over the next several years. Although the charges incurred during the quarter relating to the redemption depressed our reported earnings, we will enjoy the benefits of this long-term financing over the next ten years. 

As investors look over Sonic's first quarter, the key is to keep the big picture in mind. This is a company that's transitioning as it tries to prepare for peak auto sales -- and what follows a peak. As same-store sales flatten and revenues stall, Sonic is focusing on acquiring small dealership groups, pushing its product mix toward less-volatile and more-profitable luxury vehicles, and focusing on making its purchase process less of a hassle by reducing paperwork. Sonic is a good example of a company that's choosing to endure short-term pain so it can put itself (and its shareholders) in a better position for the long term.

How about the parts supply side?

Lear Corp., which Automotive News pegged as the 10th-largest global auto parts supplier based on revenue, posted a strong quarter -- but investors weren't optimistic enough to push the stock price higher after the conference call. Lear's revenue increased 7% in Q1 to almost $5 billion. New business and increased production volume pushed the top line higher year over year, and its bottom line net income jumped a more impressive 23% to $306 million. Adjusted earnings per share had a similarly strong 26% run higher compared to the prior year, to $4.27.

Lear is the world's second-largest automotive seat maker, and is well positioned with its electronic components and systems business to benefit as vehicles increasingly become interconnected with our digital lives. The good news is that margins in both of its business segments are improving, and the latter (e-systems) generates a juicier margin.

Image showing seating adjusted margin increasing to 8.5% and e-systems increasing to 14.9%.

Image source: Lear Corp.'s Q1 April, 26, 2017 presentation.

As President and CEO Matt Simoncini said in the earnings press release:

Our industry-leading cost structure and product capabilities are driving outstanding financial results and market share gains in both product segments. We have a record sales backlog that will provide continued profitable sales growth and superior shareholder returns.  This year, we celebrate our 100th anniversary, and the Company has never been in a stronger competitive position. I have never been more optimistic about our future.

Auto parts suppliers will be intriguing businesses over the next couple of decades. On one hand, the dollar amount of technology in cars should continue to increase, especially as automakers drive toward the goal of making them autonomous. On the other hand, automakers worldwide are increasingly cutting costs and consolidating their business with fewer suppliers, driving competition higher and prices lower. An investment in any particular parts supplier thus could end up a big winner or a big loser.

Ultimately, while the auto industry is cyclical and often highly capital intensive, what's clear is that those companies that are well prepared for a plateau in sales -- and that are actively transitioning to adapt to the evolution of the industry -- have better odds of providing more profit to shareholders. Keep that in mind when shopping for auto industry stocks. 

Daniel Miller has no position in any stocks mentioned. The Motley Fool has no position in any of the stocks mentioned. The Motley Fool has a disclosure policy.

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