Every day, Wall Street analysts upgrade some stocks, downgrade others, and "initiate coverage" on a few more. But do these analysts even know what they're talking about? Today, we're taking one high-profile Wall Street pick and putting it under the microscope...
New car sales in the U.S. slumped in July, falling 3.7% in comparison to July 2017. That was a disappointment after the 5.2% increase in sales we saw in June, but basically a continuation of the topsy-turvy nature of this year's car market, where sales also fell in April, rose in May, and year to date are up only an anemic 1.1%.
But somebody seems to have forgotten to tell automotive investors that things aren't really going great.
In a series of new stock ratings just out this morning, analysts at SunTrust Robinson Humphrey note that two of the country's biggest automotive retailers still cost roughly the same valuation they've averaged over the past 10 years -- even though we're at or near the peak of the car market. One other stock, however, appears to be selling at closer to a discounted price.
Surprise, surprise: That's the stock SunTrust thinks you should buy.
Cars aren't exactly rushing off the lot these days -- but sales are a lot less bad than you might expect. Image source: Getty Images.
Rounding up the usual suspects
The three car dealers SunTrust reviewed this morning are Asbury Automotive Group (ABG -1.74%), AutoNation (AN 0.23%), and Penske Automotive Group (PAG -0.23%).
Priced below $76 today, SunTrust sees Asbury Automotive stock rising to perhaps $78 a share over the next 12 months -- a low-single-digit increase that's basically in line with the growth rate that car sales have enjoyed so far this year. That's probably no accident. "[B]ased on its current sales mix of new and used cars," SunTrust argues, according to TheFly.com, Asbury stock "should grow in line with the overall auto dealer industry."
The analyst is more optimistic about AutoNation, but only slightly so. On the one hand, SunTrust likes AutoNation's efforts to expand into "less-cyclical businesses like collision and used vehicle stores" to reduce its dependence on new car sales. Still, SunTrust says the stock is "over-index[ed]" to new car sales, which will continue to have "outsized" impact on its sales growth until the new initiatives take off. In fact, in the short term, SunTrust worries that AutoNation's investments to grow new businesses could hurt its profit margins, exacerbating the effect of slow sales growth. As with Asbury, SunTrust only sees this one going up a couple of bucks over the next 12 months -- from $46 and change to perhaps $48 a share.
In contrast, SunTrust has higher hopes for Penske Automotive Group stock. Priced below $52 a share today, SunTrust predicts Penske will rise to $60 within a year as the company's commercial heavy duty truck retailing segment helps to blunt the effects of a "difficult" consumer cars market.
Admittedly, commercial trucks only account for about 5% of Penske's annual sales, according to data from S&P Global Market Intelligence. However, the analyst also likes Penske's strategy of expanding used car sales, especially in light of a strengthening market for off-lease vehicles.
Running the numbers
Valuation-wise, SunTrust notes that Asbury looks "fairly valued" today, and deserves no more than a hold rating. This is because Asbury stock is "trading in the middle of its historical range," explains SunTrust. Likewise with AutoNation, which also gets a hold, the analyst argues its stock is "in the middle of its 10-year historical valuation range."
Penske Automotive stock, though, is again the exception. As SunTrust points out, the stock is selling for only nine times forward earnings. Inasmuch as Penske stock has ranged between valuations of eight and 13 times forward earnings historically, SunTrust believes Penske Automotive Group sits sufficiently close to the "low end" of its trading range to merit a buy rating and a $60 price target.
Do the numbers add up?
Not prepared to take SunTrust at its word on these valuation arguments? That's probably prudent. Just to confirm that the analyst's arguments are accurate, I ran the numbers myself.
According to data from S&P Global, Penske's lowest annual valuations relative to forward earnings (its price-to-next-12-month-earnings ratios) have averaged 8.8 over the last 10 years. The stock's highest forward P/E ratios, on the other hand, have averaged 16.3. Thus, the situation as I see it is actually more attractive than the one SunTrust describes. At 9.5 times forward earnings today, Penske Automotive stock sits within less than one full multiple to earnings of its lowest average multiple over the past decade -- a very propitious sign that the stock has nowhere to go but up from here.
But here's a surprise: AutoNation's forward P/E has actually averaged between 11.6 (at its low point) and 17.1 (at its high) over the past 10 years. At today's valuation of 9.4 times forward earnings, it's arguably ever more attractive than Penske!
As for Asbury, its forward P/E has ranged from an average of 8.2 to about 14.7 over the past decade. At 9.5 times forward earnings today, Asbury stock is a bit farther from its usual low point than is Penske -- but only a bit, and probably not significantly different to justify calling one stock a buy and the other stock a hold on this metric alone.
What it means for investors
So what's the upshot for investors? All three of the car dealers that SunTrust reviewed today currently sell at, below, or very near to their lowest forward P/E ratios of the last 10 years. On the one hand, that does suggest the stocks are worth watching as potential value candidates -- and in contrast to SunTrust, I honestly don't see any compelling reason to prefer one of these stocks over the others.
On the other hand, of course, low P/E ratios are exactly what you'd expect investors to bid at the top of a cyclical market, where they're not sure how sustainable company earnings will be on the other side of the cycle. Personally, though, I'm kind of surprised at how well auto sales have been holding up so far -- after all, we've been hearing the market was at its cyclical peak for at least a couple of years now, yet sales stubbornly refuse to fall off the cliff.
If sales continue to hold up well, and single-digit sales gains is the worst news we can expect, it's just possible that not just one, but all three of these stocks are still worth investing in.
