The Business Of
Cars | AutoNation | What Do They Do With Their Profits?
Morning All!
Yesterday we put together AutoNation’s costs with their revenues. And we’ve covered a fair amount this week. So let’s have a quick recap…
Revenue: AutoNation make a staggering ~$20bn of revenue by selling new and used cars from their 247 car dealerships.
Costs: Despite being only ~20% of revenue, the after-sales and finance segments make up >60% of profits because of their lower costs!
EBIT Margin: AutoNation has had low but incredibly consistent margins. From 2000-2020, their EBIT margin went outside a tight 2.8-4.3% range just once!
And speaking of margin. It is a Thursday morning. Which means it’s time to take a look at our famous TBO EBIT Margin ranking! Below, we can see our ranking updated to include AutoNation. And we can see that the car dealership group’s margin is one of the lowest we’ve ever covered on TBO!
Now, a ~5% margin really isn’t the most exciting figure we’ve seen on TBO! It’s not the >30% margins we saw when we looked at The Business Of Semiconductors or The Business Of Banking. And low margins usually highlight a company with low pricing power.
But then, here’s a question - why does Warren Buffett own one of the largest car dealership groups in America? And why does Bill Gates own ~25% of AutoNation? Surely they should be investing in companies with higher margins, right? Why are both these intelligent individuals investing in companies with such low margins? Well, that question is what we’re going to be answering today! Let’s dive in!
AutoNation, The Buyback King!
So, to kick us off, let’s as always look at the waterfall chart below. Which shows us how AutoNation have spent their cash from operations (CFO) since 2003.
We can see that the company has made ~$12.4 billion in CFO over the last 20 years. And we can see that the main use of that cash has been share buybacks! A whopping ~$11.2 billion worth of cash has been returned by AutoNation to their shareholders in the form of buybacks!
Now, to put that ~$11.2bn into context, we can look at the table below, which shows us which companies on TBO have spent the highest proportion of their cash on buybacks.
We can see that Goldman Sachs spent ~50% of their cash on buybacks. McDonald’s is second with 55%. But AutoNation’s ~90% is absolutely miles ahead of everyone else! They LOVE buying back their shares!
So, maybe this huge emphasis on cash return is the reason why Bill Gates likes AutoNation’s shares? Well we’ll find out shortly as we’ll dive into buybacks in more detail in just a moment. But first, we’ll look at one of the other main ways AutoNation has used their cash from operations. And that’s acquisitions!
Now, before we get into the details, let’s first remind ourselves - why are acquisitions so common in this industry? Well, the answer is because the US car dealership industry is incredibly fragmented. As the chart below shows, there are ~16,000 car dealerships in the US. And the top 6 car dealership groups (including AutoNation) only control ~7% of them! So, what’s one way AutoNation can grow their revenues? Buy some of the other 15,000 dealerships and grow their number of locations!
Wayne Huizenga - The Olden Day Elon Musk!
Now, on TBO, we’ve never really looked at a company that’s grown their revenues by acquiring more locations. The closest thing we’ve seen was in The Business Of Tesco, where we looked at how Aldi has grown revenues by rapidly opening new stores. The chart below shows how the German discount supermarket grew its UK store count from 470 in 2012 to 1,000 last year!
Whilst this is similar to what AutoNation have been doing… it’s still slightly different. Because AutoNation aren’t just opening new dealerships. They’re BUYING local competitors and taking over their locations!
So, whilst Aldi are buying land and building their supermarkets from scratch. AutoNation are actually buying already established businesses… which as we’ll see in a moment, isn’t cheap!
Now, a couple of examples of companies that grew like AutoNation are Blockbuster (once, the largest video rental company in the world) and Waste Management (the largest rubbish collection company in the world). Both companies started by having very few locations. But then grew rapidly by acquiring most of their local competitors.
Now, why am I talking about Blockbuster and Waste Management? Well, this is a slight detour. But it’s worth it - because this is absolutely mind-blowing. Guess who was the founder of Waste Management and Blockbuster? Well, it was a chap called Wayne Huizenga - the same guy who founded AutoNation! How crazy is that?! Mr Huizenga took the strategy of starting small and acquiring lots and lots of locations and applied it to 3 industries! First to rubbish collection. Then video rental stores. And then car dealerships! Amazing. You can read more about the olden day Elon Musk here! Oh and by the way, Waste Management is actually even bigger than AutoNation - the company is currently valued at ~$73 billion!
Okay, so we know AutoNation was built through acquisitions. We know there’s thousands of car dealerships around the US that the company could buy. So, AutoNation must surely be acquiring loads of dealerships right? Well, surprisingly, no!
Since 2010, AutoNation have only increased their dealership locations from 206 to 247. Which is just a ~2% increase per year. Less than that ~7% growth we saw from Aldi earlier. So, here’s a question - why aren’t AutoNation doing more? Why aren’t they spending more of their cash on acquiring other dealerships? And as we’ll see in a moment, why are AutoNation actually selling some of their stores?
Well, the first reason is because acquiring car dealerships is expensive! Since 2010, AutoNation have spent ~$2.5 billion to acquire ~99 dealerships. (They’ve acquired 99 and sold 58 which is why overall, they’ve increased their dealership count by 41). Which works out to a handsome ~$25 million per dealership! Now, is that really right? Do car dealerships really cost that much to acquire? Well, obviously dealership values vary. The bigger the dealership, the more revenues and profits it has, the more expensive it’ll be to acquire.
But if we look at AutoNation’s biggest competitor, Lithia Motors, that figure of ~$25 million per dealership looks about right. From 2020-2022, Lithia Motors bought a whopping 138 dealerships and paid ~$4.7 billion in total. Which works out to ~$34 million per dealership. However, quick note here. The acquisition Lithia Motors is making in the UK seems to be happening at a much cheaper rate. Paying $481m for Pendragon’s ~160 dealerships works out to ~$3 million per dealership! Bargain?!
So, that’s clear - dealerships are expensive to buy - at least US dealerships! Which is why AutoNation haven’t been hoovering up smaller US dealerships so easily. But the second reason why AutoNation may not be able to acquire dealerships as fast as they’d like is because of restrictions from car manufacturers. What do I mean?
Well, I’ll keep this brief. But basically, car manufacturers aren’t that keen on dealership groups like AutoNation or Lithia Motors getting too big. Why? Because at present, car manufacturers have a strong bargaining position vs dealerships. They control the prices at which they’ll sell new cars to dealerships. But what happens if a dealership group - like AutoNation - grows their market share and has thousands of stores? Well, the dealership group becomes more powerful and can begin to challenge manufacturers on their pricing! Because of this, manufacturers have pretty strict limitations on which regions dealership groups can actually expand to!
AutoNation Buys Back Shares, Bill Gates Brings Out The Dab?
Okay so that’s acquisitions. Let’s turn our attention back to share buybacks. And to kick us off, let’s break down some numbers. From 2003 to 2022;
AutoNation’s revenue grew at ~2% CAGR.
Profit (Net Income) grew at ~6% CAGR.
But profit per share (also called EPS) grew at ~15% CAGR.
Now, here’s a question - why is there such a difference between profit growth (~6%) and profit per share growth (~15%)? Well, it’s all to do with share buybacks! And we saw something very similar in The Business Of Union Pacific Corporation.
The chart below shows us how AutoNation’s number of shares outstanding has reduced from 287 million in 2003 to just 57 million in 2022. That’s a massive ~80% reduction! Which means AutoNation have been buying back ~8% of their shares every year on average. And what happens when the number of shares go down? EPS goes up! For a reminder of how share buybacks boost EPS and shareholder return, check out this simple Investopedia article!
Okay, so we’ve seen how much AutoNation love buying back their own shares. But I have a second question - why exactly do AutoNation love share buybacks so much?! Well, the answer is pretty simple. Other than using their cash to acquire more car dealerships… the company’s management must feel that their best bet of improving EPS is through reducing the share count!
And this love of share buybacks has helped AutoNation’s shareholders - including Bill Gates, their largest shareholder - over the years. As we’ll see in a moment, Mr Gates and friends have made ~8x their money owning AutoNation’s shares since 2010! That’s ~29% per year for the past 12 years!
AutoNation Buys Stock, Lithia Buys Dealerships - Which Is Better?!
Okay, time to wrap up. And there’s something really interesting to close on today. We’ve just seen that AutoNation’s shareholders would be pretty pleased with how things have gone over the last decade. The company has grown its revenues and bought back a load of shares. And the stock price has gone up ~8x since 2010.
However, how does that ~8x return compare to AutoNation’s competitors? Well, quite astonishingly, AutoNation’s ~8x return is actually the SECOND-WORST performance of all the top 6 car dealership stocks in America! Lithia Motors, AutoNation’s largest competitor, has seen their stock rise a scarcely believable ~42x since 2010!!!
And the reason for this is simple. Both companies have opted for 2 very different strategies. 1) AutoNation have spent their cash buying back their own shares. 2) Lithia Motors on the other hand have spent their cash on acquisitions - buying other dealerships.
And whilst both companies have seen very, very solid EPS growth over the last 12 years, the EPS growth at Lithia Motors (45% CAGR) has outpaced the EPS growth at AutoNation (27% CAGR)! The table below demonstrates this.
How amazing is that? AutoNation have done incredibly well to achieve ~27% EPS growth per year and their share price has returned ~29% per year for over a decade. However, they’ve STILL lagged their biggest competitor, Lithia Motors. Tough school!
18th Jan 2024
And that’s a wrap! I hope you enjoyed that exploration of AutoNation’s acquisition and buyback strategies! To close The Business Of AutoNation tomorrow, we’ll look at the future of dealerships. And we’ll also dive deeper into the used car industry - looking at not 1, not 2, but 3 massive used car players!
Have a fabulous day!
The Business Of Team