Why does Wall Street hate car dealer Sonic Automotive (NYSE:SAH)? It's a cheap stock -- its price-to-earnings over earnings-per-share growth, or PEG, ratio is less than 1 -- yet analysts have a consensus hold/sell recommendation on it. Given that Warren Buffett recently bought the largest privately owned car dealership in the U.S., the Van Tuyl Group, is Wall Street missing something with Sonic Automotive?
Car dealerships are about to change
The Internet has changed many aspects of business, and the car retail industry is not immune from its effects. Indeed, Elon Musk is doing everything he can to disrupt the traditional dealer-franchise model by selling Tesla Motors cars directly to customers. Moreover, consumers are increasingly getting used to using pricing information from online sources in order to make more efficient purchasing decisions -- it beats haggling with a salesperson on a car lot.
With these kinds of pressures building on the industry, it's essential that car dealerships adjust to new realities, and the good news is that Sonic Automotive is doing just that. The bad news is that Wall Street doesn't like the uncertainty that comes with change, and there is a lot of it coming at Sonic Automotive.
The company's growth strategy contains three elements:
- Rolling out its "One Sonic-One Experience" initiative, which uses technology to simplify the buying process
- Developing a stand-alone presence as a national preowned car retailer
- Acquiring new car franchise locations.
Simplifying the car-buying process
On the recent conference call, Sonic's vice chairman, David Smith, stated that the purpose of the "One Sonic-One Experience" initiative is "to put the power into the customers' hands, where they can enjoy the automotive purchasing experience with one associate at one price and in one hour." The "one price" initiative is a natural progression of its "True Price" strategy (fully implemented in 2013), which set pre-negotiation prices within just $300 of the lowest acceptable price.
Naturally, there are some concerns as to whether this strategy will leave Sonic susceptible to rivals undercutting prices. Moreover, are customers willing to pay a perceived premium for the experience? In its defense, the technology should allow Sonic to adjust prices on a regular basis, and pricing is probably less of an issue in the luxury car market that Sonic has heavy exposure to.
Preowned expansion, acquisition strategy
The company plans to start its stand-alone used-car dealerships, called EchoParks, with the opening of a store in Denver. Despite Carmax's leading position in the used-car market, the market remains heavily fragmented, and there is an obvious growth opportunity for larger firms to consolidate the industry. Moreover, used cars already contribute a large part of profits at Sonic Automotive -- and come with higher margins than new-car sales. Here are the revenue and margin figures for the first six months of 2014:
|Segment||Revenue (in thousands)||Gross Profit (in thousands)||Margin||Share of Gross Profit|
|New Car Vehicles||$2,445,397||$140,866||5.8%||20.8%|
|Used Car Vehicles||$1,163,684||$78,167||6.7%||11.6%|
|Parts, Service and Collision Repair||$647,905||$312,006||48.2%||46.2%|
Incidentally, the rest of gross profit comes from its financing and insurance activities -- another area in which Sonic plans to expand. Moreover, the importance of servicing revenue (46.2% of gross profits) highlights the necessity to generate car sales volume rather than hold firm on margin. If Sonic delivers a good experience to a buyer, then they are more likely to come back and use its high-margin service solutions.
EchoPark also represents somewhat of a new concept in that the stores will differ from the traditional car lot display prototype. Instead, EchoPark will act as a showroom, with customers able to test-drive cars that are held in a regional inventory. This should allow Sonic to occupy premium locations while storing cars elsewhere. It's all good in theory, but will it work?
All told, Wall Street seems to be looking at the execution risk in Sonic Automotive's strategy and questioning whether the "One Sonic-One Experience" will work. Will margin come under pressure as a result of it? Moreover, the EchoPark concept is unproven. In the long term, these moves may make perfect sense -- the industry will inevitably see technology change it -- but Wall Street will fret over their execution in the meantime.
In a sense, it's a classic investment conundrum. Are you willing to take on short-term risk if you believe that in the long term Sonic Automotive's initiatives will pay off? If you are, then go ahead and buy the stock, or at least take a nibble and monitor events with a view to buying more if its plans run smoothly. The initiatives make perfect sense, and are in line with how retail is changing elsewhere.
Lee Samaha has no position in any stocks mentioned. The Motley Fool recommends and owns shares of CarMax and Tesla Motors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.