This article is part of our Rising Star Portfolios series.
My name is Mike, and I have an addiction: I drive, every day. I can't help it. And the withdrawals? Ugh, don't ask. It's this same compulsion that drove me to purchase shares of Asbury Automotive
Fortunately, for this investment idea, the American public hasn't been buying enough cars to feed its addiction. For a few years running, in fact, car purchases have languished below the scrap rate. That means that for some of the cars that have been retired, a replacement has yet to hit the road.
That's exactly why I bought Asbury Automotive for my Rising Star portfolio. At some point, Americans need to buy more cars. They like going places. And as one of the largest dealers, Asbury's poised to benefit from this trend. This quarter's results bear that out: Same-store new- and used-car sales grew 18% and 16%, and adjusted earnings per share grew 35%.
Gross profits at parts and services, the company's cash cow, grew 8%. Revenues from financing and insurance grew 26% on increased sales volumes and credit markets' easing. Because there's little incremental cost on financing and insurance, that cash flowed straight to the bottom line.
The quarter's results are a testament to two things: an ongoing (and somewhat inevitable, though timing is uncertain) recovery in vehicle sales, and Asbury's efforts at driving operating efficiencies. The market's response was less enthusiastic. It dithered over the impact of supply disruptions from Toyota and Honda and declining gross margins on new cars. They're legitimate concerns. However, even these huge near-to-medium-term issues should eventually subside, albeit not immediately.
My take is a little different: We've seen this before. Gross profits on new vehicles slipped as dealers slugged it out over market share, amid a still-tentative recovery. And this has happened before. If history's any indication, margins should recover in time. The supply disruptions in Japan, while unfortunate and uncertain in duration, are also temporary.
More importantly, at today's prices, none of it matters too much. Asbury shares trade at about 11 times my estimate of 2011 cash flow. That, in effect, assumes car sales will not meaningfully recover from current levels, margins will continue to slide, or some combination of the two. Don't get me wrong, this is quite possible in the near term. Unemployment is still high, and housing still an albatross.
But in the long term, I think that's not so likely. I'll take that bet.