Company Reports

Lithia Motors' first-quarter results suffered from gross margin coming in lower than were modeling for the full year. Adjusted diluted EPS of $6.11 fell 27.6% year over year and missed the $7.89 LSEG consensus. After the February close of the Pendragon deal in the UK, which is a region that has less lucrative financing operations than US dealers, in the April 24 slide deck management lowered its so-called “future state” (think 2030s) long-term operating margin target by 200 basis points to over 5% from 7%. We include floorplan interest in our midcycle operating margin number, and we have lowered our midcycle operating margin by 30 basis points to 4.2%. These changes reduce our fair value estimate by 11% to $445 from $500. Although this is a large valuation cut, we still find Lithia’s long-term growth story very attractive; however, we think our valuation is one that the stock will need beyond 2024-25 to grow into.

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

Lithia Motors finished 2023 with fourth-quarter results reflective of the trend back toward normalized levels that all dealers we cover are dealing with. Fourth-quarter adjusted diluted EPS fell 9% year over year to $8.24, which matched the London Stock Exchange Group consensus, while total revenue rose by 10.5% to a fourth-quarter record. Same-store sales fell by 2% on used vehicle headwinds. CEO Bryan DeBoer made changes to the 2025 $50 billion revenue target and capital allocation plans. As we've heard on other dealer calls this earnings season, Lithia feels some sellers of dealerships are asking too high a price while at the same time Lithia's stock is now cheap enough to merit more share repurchases, which we agree with. DeBoer now thinks 2025 revenue could be in the mid-$40-billion range, while we had been modeling just over $50 billion. This change would reduce our fair value estimate by about 7%, but we'll wait for the 10-K to be filed before making a change to roll our model and incorporate other variables that will change at that time, such as a lower share count for more buybacks.

Most automakers reported final sales numbers for 2023 on Jan. 3. Adjusting for one selling day fewer, Wards put the year-over-year December sales increase at 17.3% and the seasonally adjusted annualized selling rate at 15.83 million, up from 13.55 million in December 2022. Full-year sales increased 12.4% to 15.46 million. We think the worst of the chip shortage is finally behind the industry, but we expect some supply shortages in 2024. As inventory continues to recover, we expect incentives as a percentage of average transaction price to keep rising from artificially low levels of barely above 2% in late 2022 (currently just over 5%), which will pressure automaker and dealer margins in 2024 relative to the past two years. Better inventory and U.S. interest rates likely done rising should bring some consumers back to the showroom. Affordability remains a challenge though, so we expect only a small increase in 2024 light-vehicle sales to the high 15 million range.

At the Los Angeles auto show on Nov. 16, Hyundai announced a partnership with Amazon in which, starting next year, some of its dealers will sell new vehicles on Amazon.com. The news sent each of the six franchise dealers and CarMax down about 5%-8%, which we think is a large overreaction predicated on fears of Amazon taking share away from dealers. Such a risk is not even possible on new vehicle sales due to state franchise laws, nor do we think it is likely that Amazon wants to do all aspects of auto retailing such as handling and disposing of trade-ins, service, and finance and insurance offerings. Service is a very underappreciated benefit that dealers provide customers when comparing the traditional auto industry to digital retailing and electric vehicle startups' direct sales formats. Should Amazon directly sell used vehicles someday, CarMax would have more competition, but it also has the ability to sell via brick-and-mortar, digital-only, or any combination of both depending on what the customer wants, something a digital-only retailer cannot offer. Our auto coverage has been implementing omnichannel tools for years and we doubt that any of their management teams are surprised by the Amazon news.

Lithia’s third-quarter adjusted diluted EPS of $9.25 fell 16.5% year over year and missed the Refinitiv consensus of $10.08, but we don’t see anything in the results to merit a fair value estimate change. We still see Lithia’s growth runway as excellent, as the firm continues to expand at an aggressive rate via acquisitions and has many new end markets to pursue long-term, such as its Driveway Finance captive finance arm, electric vehicle charging, fleet management, and a dealer management system joint venture with Pinewood Technologies as part of the pending acquisition of U.K. dealer Pendragon (see our Sept. 18 and Oct. 2 notes). Pendragon announced on Oct. 25 that its shareholders have overwhelmingly approved the deal, so the final hurdle is approval from U.K. regulators. The deal is still expected to close before year-end. The North American DMS joint venture with Pinewood is likely to launch in about two years, per CEO Bryan DeBoer, as Pinewood needs time to have data links with all 50 U.S. state motor vehicle departments.

Lithia’s agreement to buy the U.K.’s third-largest auto dealer, Pendragon, as discussed in our Sept. 18 note, brought subsequent rival bids from Penske Automotive Group and AutoNation, both for 32 pence per share. On Oct. 2, Lithia announced a new agreement with Pendragon for higher consideration equivalent to 35.4 pence per share. Cash paid by Lithia will now be GBP 397 million, up from GBP 280 million, and we are leaving our fair value estimate unchanged. The deal’s structure is not different from our Sept. 18 note and includes GBP 30 million paid by Lithia to acquire 16.7% of Pendragon’s remaining operations, which will become a publicly traded software as a services company called Pinewood Technologies. The extra GBP 117 million cash contribution is entirely for Pendragon's Evans Halshaw mass market brands locations, the Stratstone premium brands stores, the CarStore online used vehicle marketplace, and Pendragon's vehicle fleet management unit.

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

We are leaving our Lithia Motors fair value estimate in place after modeling the firm's announced acquisition of Pendragon, the U.K.'s third-largest auto dealer group. The deal is expected to close in the fourth quarter and bring annual revenue of about $4.5 billion. Lithia's 2023 acquired annual revenue is now $8 billion and the firm is maintaining its 2025 revenue and EPS targets of $50 billion and $55-$60 per share. The purchase price is $350 million, or GBP 280 million, and will likely be financed via existing credit facilities and cash. Lithia had discussions last year to buy Pendragon, but they ended without a deal, so Lithia instead entered the U.K. this March via the purchase of Jardine. With both groups, Lithia expects to have 3.6% of the U.K. new vehicle market.

Lithia Motors' second quarter looked strong to us with acquisitions driving a 12% year-over-year revenue increase to a second-quarter record. Same-store revenue, however, declined by 2.9% mostly from poor used vehicle affordability for consumers continuing to plague used vehicle retailers. Adjusted diluted EPS fell 10% to $10.91, but last year was a very tough comparable for all dealers, and EPS still beat the $9.26 Refinitiv consensus. We lowered our fair value estimate to $500 per share from $507 due to 2023 share buybacks not occurring to the degree we were modeling. We have lowered our 2023 buyback spending to $250 million from $400 million, which increased our share count by over 7% and reduced our fair value.

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

We are not changing our Lithia Motors fair value estimate despite first-quarter results that missed Refinitiv consensus. We don’t see Lithia’s 2025 EPS story of $55-$60 on $50 billion in revenue in danger of not happening. Management has long said it expected profits to come down from recent levels as new vehicle profitability has been turbocharged from the chip shortage reducing supply. Adjusted diluted EPS of $8.44 missed the $8.77 consensus and fell 29% year over year. Same-store revenue fell 5.1% with all segments declining except service, which grew 9.4%. Same-store unit volume fell 6.3% for new vehicles and 2.4% for used vehicles, while those segments’ gross profit per unit declined by 19.7% and 30.3%, respectively. New vehicle profits are slowly returning to a more normalized level from the chip shortage highs, while used profits remain difficult for retailers due to expensive inventory acquisition costs and poor consumer affordability.

We are not changing our Lithia Motors fair value estimate after the company announced the acquisition of U.K. dealer Jardine Motors Group. Terms were not disclosed and Lithia CEO Bryan DeBoer in an Automotive News interview said the deal was on more favorable terms than U.S. acquisitions. We estimate the price at between $400 million to $500 million and Lithia said the deal was financed from existing balance sheet capacity (that is cash and credit lines).

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

Lithia Motors rarely fails to beat Refinitiv consensus, but fourth-quarter adjusted EPS declining 20.5% year over year to $9.05 missed the $10.10 consensus and sent the stock down 8% during Feb. 15 trading. We are leaving our fair value estimate in place, but we will revisit all modeling assumptions after the 10-K is filed. We see no reason to change our thesis that Lithia is on track to meet its 2025 revenue goal of $50 billion (up from $28.2 billion in 2022) and EPS of $55-$60 ($44.42 in 2022). The quarter had strong headwinds from overhead costs and a large decline in vehicle sale volume from Ford and Stellantis stores, which combined were about 20% of volume. Management did say these two firms have increased incentives in 2023, and February saw a large pivot to move out 2022 model-year inventory, so we think the volume problem should be short-lived.

2022 U.S. light vehicle sales per Wards were 13.7 million, an 8.1% decline from 2021 and their worst year since 2011’s 12.8 million. December sales, however, grew 4.9% year over year with the seasonally adjusted annualized selling rate at 13.31 million, up from December 2021’s 12.72 million. The chip shortage rather than poor demand is to blame and we expect one more year of constrained production for the industry. Regardless of high interest rates and average transaction prices over $45,000, we feel U.S. autos have been at recessionary levels for a lot of the time since spring 2020, so we expect 2023 sales to rise by midsingle digits. Gradual improvement in new vehicle inventory should help used vehicle pricing eventually be more affordable for consumers, which is also good for dealers’ used vehicle margins that are currently squeezed by high procurement costs.

Lithia Motors' third-quarter results were a rare earnings miss versus Refinitiv consensus, but we still see no reason to change our fair value estimate because we remain confident management can achieve its 2025 targets of $50 billion in revenue and $55-$60 in EPS. Adjusted diluted EPS of $11.08 ($11.84 consensus) suffered a $0.54 foreign exchange hit from the strong dollar translation on the firm’s Canadian earnings. Although the stock is down by about 8% after the release, the results to us still look mostly solid. Same-store revenue rose 3.7% year over year and same-store gross profit fell by 3.8%, with all segments posting gross profit declines (except service). We like that management is repurchasing its stock well below our fair value estimate with third-quarter buybacks totaling about $37 million and nearly $650 million through third quarter this year—$77 million of authorization remains available, and total liquidity is about $2 billion.

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.