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By Erik Kobayashi-Solomon | 10-25-2010 03:56 PM

No Need to Haggle for This Auto-Dealer Bargain

Fears over Lithia Motors' debt load and exposure to Chrysler are overblown and have left the stock looking cheap, says Morningstar's Dave Whiston.

Erik Kobayashi-Solomon: Hi, I'm Erik Kobayashi-Solomon, Co-Editor of Morningstar's OptionInvestor. Today, it's my great pleasure to welcome Dave Whiston, who is the auto analyst here at Morningstar to talk about Lithia Motors.

Dave, thanks for coming.

David Whiston: Thanks, Erik

Kobayashi-Solomon: Dave, as you know, just recently I did an option strategy on Lithia, a bullish option strategy and just want to find out a little bit more about this company.

So, Lithia Motors is a publicly traded dealership group, and I think probably people would know like the Penske Group, racing fans would know the Penske Group a little bit better. Can you just talk about the publicly traded dealership groups, and what their difference in let's say geographical and business focus is?

Whiston: Sure, starting in the late '90s, a lot of ambitious entrepreneurs started to take their dealerships public.

Kobayashi-Solomon: Mainly these are kind of like family-owned businesses really, right?

Whiston: Yeah, in some cases, yeah. Sonic Automotive was controlled by the Smith family; Lithia Motors is controlled by the DeBoer family. It's a really interesting business model though because they grow mostly through same-store sales growth and primarily through tuck-in acquisition.

So they are always looking at – the dealership industry is incredibly fragmented. So, these larger players like Lithia, AutoNation, Penske, they are always looking for acquisition targets and they just slowly keep growing.

Kobayashi-Solomon: So, when you say a tuck-in acquisition, this is basically, let's say a Penske Group or Lithia Motors sees a mom-and-pop dealership and they buy that dealership from the private owners?

Whiston: Exactly. It's usually one store at a time, so it's very gradual. You don't see Penske looking to go and buy one of the other big publicly traded dealership, for example.

Kobayashi-Solomon: So when you think about the dealership groups, how do you think about their geographical dispersion or their business focus?

Whiston: Really, the only big differences are the balance sheet, the brand mix and store geographies. So, when you look at all the publicly traded dealers, you see a little bit of diversification in that. AutoNation, for example, is a very California and Florida focused; Group 1 based in Houston, they are big in Texas and Oklahoma and also on the East Coast; Sonic and Asbury are big on the Southeast, but all the publicly traded dealers except for Lithia are very common and they are focusing on suburban large metro areas, Atlanta, Chicago, East Coast, Houston, LA.

Kobayashi-Solomon: Lithia really has carved out its own niche in the rural – amongst rural owners, right, can you talk a little bit about that? It's all West of the Mississippi and mainly kind of rural focused, right.

Whiston: Right. Lithia is a really interesting story in that regard because they are so different from their peers. It's about 84, 85 stores now, and they are all West of the Mississippi, but they are primarily almost exclusively with the exception to say the BMW Seattle store, they are in very rural areas or very small cities like Boise. They are actually very big in Anchorage Alaska for example, Montana, they are in California too, but mostly in the Central Valley, not LA or Bay Area. Their biggest market is Texas, but it's not Houston and Dallas, it's places like Odessa…

Kobayashi-Solomon: …Odessa, Midland, right.

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