Moats Drive Auto Dealerships
The dealers are the only auto sector we cover in which all firms enjoy an economic moat.
Many investors believe the automotive industry lacks competitive advantages, but we contend that each of the public auto dealership companies we cover has a narrow economic moat. The dealers may be off some investors' radar because of their relatively small market caps, but we think their moats are quite strong. Moreover, Group 1 Automotive (GPI) and Sonic Automotive (SAH) are both undervalued, in our opinion. We see the public dealers as long-term beneficiaries of continued consolidation among franchised dealers as smaller players continue to exit, enabling more market share gains, scale, and intangible advantages from the service business and optimal inventory allocation.
Parts and Service Create Pricing Power and Good ROIC
We think the dealer sector is the best business in the automotive supply chain from a competitive advantage perspective. We see all the franchise dealers we cover having two moat sources: cost advantage and intangible advantages. Lithia Motors (LAD) has a third source of efficient scale thanks to its small-market focus. The public dealers centralize back-office operations and generate far more volume than a small dealer, which brings scale. Dealers have no burdensome retiree expenses, and the large public dealers do not depend on the health of one brand. The dealers enjoy mid- to high-single-digit gross margins on new vehicles and 100% gross margin on financing and insurance. Mergers and acquisitions also help a dealer's cost advantage and intangible advantage. The growing size of a dealer's store base enables more of the scale advantage above as well as more efficient allocation and pricing of inventory than a small dealer. For example, a dealer with many stores can take a used Toyota Camry traded in at one of its Ford stores and send that Camry to a Toyota store in another part of town.
David Whiston does not own shares in any of the securities mentioned above. Find out about Morningstar’s editorial policies.