CarMax, Inc (KMX), AutoNation, Inc. (AN): Why You Should Play The Auto Sector A Little More Aggressively

I recently published an article about CarMax, Inc (NYSE:KMX) being a defensive way to play the automotive sector, as a used car business tends to do well during recessionary times as well as good times. Today, I’d like to focus on a slightly more aggressive way to play the sector using AutoNation, Inc. (NYSE:AN), the largest new auto dealer in the United States. While I still stand by CarMax as an excellent recession-resistant play, if you believe (as I do) that the economic recovery will continue for several more years, read on.

About AutoNation

As the largest auto retail company in the country, AutoNation operates a network of 263 dealerships which sell 32 different manufacturer brands of new vehicles. In addition to its new vehicle operations, AutoNation gets 24% of its revenues from used vehicle sales, 16% from parts and service and 4% from its financing operations. Although many of the company’s dealerships have been operating under local brand names, the company decided in early 2013 that they would unify all of the company’s locations under one brand.

Auto sales tend to do better as the economy improves (particularly new vehicles), and that is exactly what is expected to happen over the next few years. New vehicle sales are projected to grow by almost 7% this year, according to industry experts, due to both the improved employment situation in the country as well as the gradually loosening credit availability.

Looking at the numbers…

At 15.1 times this year’s expected earnings, AutoNation, Inc. (NYSE:AN) seems to be fairly valued right now. Revenues are expected to rise by about 9% annually for the next few years due to a combination of the higher sales volume mentioned above as well as a higher average sales price per vehicle. This year’s earnings per share of $2.94 are projected to rise to $3.29 and $3.65 in 2014 and 2015 according to the consensus of analysts who cover the company. This corresponds to a three-year average annual earnings growth rate of 12.8%, which sounds great given the valuation.

On the negative side, AutoNation’s sales growth has been fairly inconsistent over the years, as evidenced in the chart above. What this says to us is that AutoNation, Inc. (NYSE:AN) is very recession-sensitive, and in fact lost $6.89 per share in 2008 as a result of the economic downturn. Additionally, the company does carry a relatively high debt load of about $2 billion, which certainly needs to be taken into account when valuing a company.