This economic slowdown will cause many companies in the auto sector to go under. As such, stocks related to this industry have taken a huge hit over the last year or so. This offers us the opportunity to buy companies that will outlast the recession at large discounts to their intrinsic values. Last week, we looked at certain criteria to look for in order to determine whether a company in this industry represents a good long-term purchase. More than one reader offered up AutoNation (AN) as a company possibly meeting these criteria.
AutoNation owns and operates over 200 car dealerships in the Southern United States. AN is not reliant on only selling cars, however. New car sales make up 56% of revenue, vs 24% used cars and 17% parts and service. As one might imagine, exposure to parts and service helps stabilize a company through hard times: revenue from this segment dropped only 1% through the first nine months of this year, versus a 17% drop in new car sales.
The nature of this company’s business requires it to have many fixed costs. Dealerships must be operated and kept in good condition containing a variety of product makes and models in order to make sales. As such, when there’s a drop in demand, costs can’t automatically be scaled back and thus losses occur. The company lost $1.4 billion last quarter as a result of slowing sales and a Goodwill writedown.
Considering profits will likely be negative for the next while as revenues drop and fixed costs remain, the debt level becomes an important factor in determining the company’s lasting power. The balance sheet shows a debt to equity ratio of 66%, but this jumps to 90% after including off balance sheet debt (operating leases, purchase commitments etc. as discussed here) which cannot be ignored.
The company has been mitigating this situation by negotiating buy-outs of their operating leases, reducing inventory (which releases cash) and paying down debt, however, many risks remain. If the recession is short, this company will be just fine and its stock price will rebound. However, if you think the recession will be long, or like us have no idea how long it will be and prefer to play it safe, this leveraged company, both in terms of fixed operating costs and high debt requirements, may not be the one for you.
For those interested in more info on auto dealership analysis, here’s a look at interest coverage ratios for various dealers. For those interested in a beaten down auto-related stock with little debt and a flexible cost structure, you may be interested in this article.