Investor Essentials Daily

This auto dealer is battling cyclicality with a high margin services business

November 20, 2024

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The auto industry has faced challenges from supply chain disruptions, rising interest rates, and weather-related impacts, but vehicle sales have remained steady. 

Asbury Automotive (ABG) has stood out by focusing on high-margin parts and services, which now contribute nearly half of its gross profit, providing stability against the cyclical nature of car sales. 

Despite short-term disruptions like hurricanes and stop-sale orders, Asbury continues to grow through acquisitions, investment in technology, and positioning itself for trends like electric vehicle maintenance. 

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The auto industry has faced significant challenges in recent years. Supply chain disruptions during the pandemic caused inventory shortages and drove prices to record highs.

As conditions improved, production stabilized, and prices began to return to normal levels. 

However, rising interest rates have added pressure, making financing less affordable for many buyers.

Despite these issues, vehicle sales have remained steady, averaging around 16 million annually, slightly below pre-pandemic levels but still strong.

In this environment, auto dealerships have had to adjust their strategies to maintain profitability. 

Those focusing on services like maintenance and financing, which offer higher margins and consistent cash flow, are in a better position to succeed.

Asbury Automotive (ABG) has stood out in this area, using its scale and acquisitions to drive growth while balancing the challenges of a cyclical market.

In most recent earnings, the company reported revenue of $4.2 billion, a 16% year-over-year increase driven partly by mergers and acquisitions.

However, disruptions caused by Hurricane Helene reduced new vehicle sales by approximately 1,200 units.

Management expects to recover a portion of this loss in Q4, but additional challenges from Hurricane Milton in Florida and stop-sale orders on certain Toyota and Lexus models add further complexity.

Despite these disruptions, Asbury’s parts and services segment continues to shine, contributing 47% of gross profit.

Unlike new and used vehicle sales, which are highly sensitive to economic conditions and interest rate changes, parts and services generate demand that is far less discretionary.

Routine maintenance, warranty work, and repair services are essential for vehicle owners, regardless of broader market trends.

These services create recurring revenue that is more predictable than the one-time nature of car sales.

Asbury has effectively capitalized on this stability. Gross profit from parts and services grew 16% year-over-year, supported by increased penetration of warranty-related activities and higher-margin repairs.

Moreover, as manufacturers like Toyota and Lexus address product defects through recalls, the company benefits from heightened warranty activity, which typically carries higher profit margins than regular maintenance.

The parts and services business also serves as a hedge against the margin compression observed in new and used car sales. 

While gross profit per vehicle has normalized due to easing supply chain constraints and reduced pricing power, parts and services gross margins have remained strong. 

This stability provides a buffer for Asbury as the broader auto market adjusts to post-pandemic conditions.

The company has also invested in technology to enhance its parts and services offerings. Digital tools for booking appointments, tracking repairs, and providing real-time updates improve the customer experience and streamline operations. 

This focus on convenience helps Asbury retain more service customers and capture a larger share of their lifetime vehicle maintenance needs.

Additionally, the company continues to expand its service capabilities to address emerging market trends. 

For instance, the rise of electric vehicles (EVs) presents a new avenue for growth. As the EV market grows, Asbury is positioning itself to offer specialized maintenance and repair services for these vehicles, which require different expertise compared to traditional internal combustion engines.

Furthermore, the company’s growth strategy is centered on strategic acquisitions that expand its geographic footprint and enhance its service offerings.

Asbury operates 153 new car dealerships, with a strong presence in storm-affected regions like Florida.

While exposure to hurricanes presents near-term risks, it also creates opportunities to recapture lost revenue as consumers replace damaged vehicles.

All these factors combined enabled the company to achieve a robust 15% Uniform return on assets while growing assets by 79%.

However, the stock’s low 15x Uniform P/E multiple shows concerns over the cyclicality of auto sales, particularly amid high interest rates.

While Asbury faces short-term challenges from weather-related disruptions and cyclical headwinds, the parts and services business is set to remain a stable and growing part of its operations.

As vehicles become more complex and its customer base expands, demand for maintenance and repair services is expected to grow.

Capturing this demand will be key to balancing the ups and downs in other parts of its business.


Best regards,

Joel Litman & Rob Spivey
Chief Investment Officer &
Director of Research
at Valens Research

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