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2 Unique Plays for the Surging U.S. Auto Industry

By Daniel Miller – May 17, 2015 at 8:33AM

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Interested in investing in the surging U.S. auto industry but wary of big-name manufacturers? Here are two unique stock ideas.

Chart by author. Data source: Automotive News DataCenter.

As you can see in the graph above, new-vehicle sales have been consistently surging in the U.S. over the past half-decade. Ford Motor Company did well over that time frame, with its stock rising 88% compared to the 32% gain in the S&P 500. However, many investors are wary of investing in the capital-intensive auto manufacturers, especially after the Great Recession forced General Motors and Chrysler into bankruptcy.

Savvy investors looking to take advantage of a rebounding U.S. auto industry can play it in a different way than through the well-known automakers themselves, though. Here are two unique options.

TrueCar (TRUE 3.53%)
Of the two options I present in this article, make no mistake: TrueCar is the most speculative and risky. Despite currently trading about 55% higher than its IPO price of $9, TrueCar has shed nearly 40% of its value since the calendar flipped over to 2015, and offers a more attractive entry price point. For investors willing to endure volatility and risk, this is a company in the early stages of what could develop into a very profitable business. 

Currently, TrueCar generates revenue by acting as a middleman between the millions of monthly visitors to its car-buying website and a growing network of certified dealerships. The company gives users valuable pricing information and a guaranteed price with the goal of making car buying more transparent and less frustrating. When a consumer completes a vehicle purchase using TrueCar's guaranteed price certificate, with a dealership in TrueCar's network, the dealer writes TrueCar a check for a little more than $300.

That register ring of $300 per transaction adds up quickly: In the first quarter of 2015, TrueCar users purchased more than 168,000 units from certified dealers, a healthy 34% increase compared to last year. TrueCar also generated record first-quarter revenue and adjusted EBITDA of $58.6 million and $4.3 million, respectively.

Furthermore, this is the beginning of many business segments for the young company. Just this week TrueCar launched a service called TrueCash, which will enable dealerships to target specific demographics with specific incentives to complete deals that would otherwise be left on the table. TrueCar is also developing TrueTrade, which will enable website users to lock in a guaranteed price for their used vehicle through a certified dealer.

While TrueCar is still linked to new-vehicle sales, the company can substantially grow its online presence and gain a larger piece of the sales pie in the years ahead. TrueCar accounts for roughly 4% of retail new-vehicle purchases, so there is definitely upside remaining. 

CarMax (KMX 7.65%)
CarMax is a unique play in the automotive industry, as it's linked to used-vehicle sales, rather than new. Also, it's arguably the best way to invest in the automotive industry supply chain, because it doesn't have the large, capital-intense, fixed-cost bases required for manufacturing -- and as a used-vehicle dealer it isn't invested in the success or failure of a single brand.

In addition to being less risky than auto manufacturers, one thing driving its success is that its salespeople receive the same commission regardless of which vehicle a customer buys, meaning there really are no pressure tactics during the sales process. Also, consumers enjoy a more transparent buying process, as they work with the same salesperson for financing rather than being handed off to a finance manager (as happens at standard franchised dealerships).

Another factor behind CarMax's success is its expertise in the used-vehicle industry. It's retailed over 5 million vehicles and appraised more than 21 million. Its data dates back to 1993, and competitors can't purchase this information. This gives CarMax a competitive edge when it comes to pricing its retail vehicles, or purchasing vehicles from consumers or auctions.

For investors, there are two factors that will drive CarMax higher: store expansion and market share gains. Currently, CarMax's stores reach only about 57% of the U.S. population and have an average of about 5% market share in vehicles aged 0-10 years. In the years ahead, CarMax plans to open between 10 and 15 new stores annually.

Graphic source: CarMax investor meeting presentation.

Over the past 10 years, CarMax has increased its respective revenue and EBITDA by an average of 13% and 31% annually. As the company continues to open new stores and increase its market share, look for the top- and bottom-line gains to continue. While CarMax is trading only a couple of dollars below its all-time highs, its stock price gains of near 200% over the last five years should be a trend that keeps on driving higher. 

Daniel Miller owns shares of Ford, General Motors, and TrueCar. The Motley Fool recommends CarMax, Ford, General Motors, and TrueCar. The Motley Fool owns shares of CarMax and Ford. 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.

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