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[Automotive Retail, Consumer Discretionary Sector]
Date: 01/09/2014 Current Price: USD 49.00 Recommendation: BUY
Ticker: AN:NYSE Target Price: USD 52.26
HIGHLIGHTS
Good Point of Entry: We issue a BUY recommendation for AN with a target price of
52.36 and a holding period return of 6.65%. AN is expected to reach the target implied
share price by the second quarter of 2014, an implied return of 6.65%. AutoNation is the
strongest revenue generator in the automotive retail industry, with a market share in new
vehicle sales of 29.7%. The company is in a two-stage growth trend and it has experienced the
“first-stage” phase in the past 3 years. The significant growth, which has added value to the
shareholder, with EPS growing from USD 1.12 to 2.87 in the last twelve months for a total of
156% or 26% annualized will continue as the company enters the “second-stage” in the
forecasted period.
Strong Revenues: Strategic acquisitions, a highly effective management, and strong
competitive advantage has positioned AN to capitalize from the economic recovery.
The larger sales network of AutoNation has propelled continuous growth in new vehicle
market and allowed to capture tremendous growth from positive industry and macroeconomic
trends, with EBITDA growing from USD 461 million to 816.9 million, or 77% (or 15%
annualized) since 2009. As a result, AN has enjoyed strong revenue growth after the financial
crisis, with revenues growing 29.7%, from USD 13 million in 2008 to 17 million in the last
twelve months, or at a compound annual rate of growth of 5.3%. The company is currently in
the “first stage” of a two-stage growth trend
Key Revenue growth drivers: A Highly Effective Business Model with Strong
Operational Metrics
The development and implementation of an enterprise information system will increase
productivity and overall efficiency. The introduction of an online web portal will create
synergies among stores and add value to the selling channels. As a result, AN will be
strategically positioned to capture demand from the forecasted economic expansion
Large distribution channels through the acquisition of 19 companies in the past 4 years
have significantly increased market penetration and brand positioning. As AN develops the
brand further, the company will be able to retain repeat consumers and capture new
consumer entrants
Investment Risks: The main risks AN faces are from fluctuations in economic conditions,
solvency, and short-term liquidity. The high level of debt taken on by the firm in its expansion
efforts poses challenges if combined with an economic slowdown.
52-week Price
Range
40.30 - 54.49
Average Daily
Volume
880 540
As % of shares
outstanding
0.72%
Altman's
Z-Score
4.56
2013 Dividend
Yield
-
Shares
Outstanding
121 810 000
Market
Capitalization
5.99 B
Insiders
Holdings
47.33%
BV per Share 16.37
ROE 2013E 12.4%
Debt to Capital
2013E
66.41%
P/BV 3.04
P/E 17.39
Market Profile
AutoNation daily stock prices
Valuation DCF
Company
Comparables
Estimated
Price
50.96 53.56
Weights 50% 50%
Target
Price
52.26
Source: Team estimates
Source: Bloomberg
Source: S&P Capital IQ
AutoNation, Inc.
3. COMPANY ANALYSIS
AutoNation, Inc., through its subsidiaries, operates as an automotive retailer in the United
States. As of December 31, 2012, the company owned and operated 267 new vehicle franchises
from 221 stores located in the United States, predominantly in major metropolitan markets in
the Sunbelt region.
STRONG & DIVERSIFIED BUSINESS MODEL
Revenue Drivers. The company has highly diversified revenue drivers within the sale
of vehicles. The company’s stores sell 32 different new vehicle brands. It offers a diversified
range of automotive products and services, including new vehicles, used vehicles, ‘parts and
services,’ which includes automotive repair and maintenance services, as well as wholesale
parts and collision businesses, and automotive ‘finance and insurance’ products, which
includes the arranging of financing for vehicle purchases through third-party finance sources.
Segments. AutoNation operates in three main segments: Import, Domestic, and
Premium Luxury. The Import vehicles segment, which accounts for 37% of their revenues;
consist of retail automotive franchises that sell new vehicles manufactured by Toyota, Honda,
and Nissan. The Domestic vehicles segment, which account for 33% of revenue, comprise
retail automotive franchises that sell new vehicles manufactured primarily by General Motors,
Ford, and Chrysler. Additionally, the Luxury vehicles segment, which account for 29% of
revenue, comprises retail automotive franchises that sell new vehicles manufactured primarily
by Mercedes-Benz, BMW, and Lexus.
In addition to auto sales, AutoNation provides maintenance and Auto Parts Sales and Services,
and Finance & Insurance Services. Each service took a significant market share in its sub-
industry sector (see Figure 3). The full coverage of auto service generates the company the
ability to provide convenient one-station service to consumer and the ability to pursue pricing
competitively through package sales as a whole. Its pricing strategy is flexible. After Japan's
March 2011 earthquake, inventory of new vehicles in the U.S. bottomed at 49 days in June.
AutoNation applied a new pricing software tool to test customer reaction to online prices,
with an attempt to wire every possible dollar out of the increasing scarce Camrys and Accords.
As a result, AutoNation expanded its gross margins to 17%.
Strategy. The company seeks to create long-term value for stockholders by being the
most profitable automotive retailer in the United States. To achieve and sustain
operational excellence, the company is in the process pursuing the following strategies:
Creating an industry-leading automotive retail consumer experience, both in stores and
online
Improve operating efficiency by leveraging significant scale and cost structure
Build a powerful AutoNation retail brand that represents a consistently superior
customer experience.
Increase of market share through mergers and acquisitions
TALENTED MANAGEMENT WILL CONTINUE TO ADD VALUE TO THE COMPANY
AutoNation management has a combined 130 years of experience in the automotive
industry. Currently, the management team of AutoNation consists of five (5) members. The
team is led by Mike Jackson, Chairman of the Board of Directors and CEO since 1999, a
veteran of the auto industry. Prior to joining AutoNation, Mr. Jackson worked from 1990 to
1999 at Mercedes Benz USA, DaimlerChrysler AG’s North American operating unit, where
he held several high-ranking positions including Chief Executive Officer (1997-1999). Under
his leadership, AutoNation has become the leader in the auto retailer industry. The remaining
management team members brings a vast experience of the auto industry: Michael E. Maroone
and Alan J. McLaren, and automotive related corporate governance development: Jonathan P.
Ferrando. Cheryl Scully is the interim CFO due to Mike Short’s departure on January 7, 2014.
New
Vehicle
Sales
Used
Vehicle
Sales
Auto
Parts
Financial
Service
29.47% 14.65% 4.75% 32.72%
Figure 3. Bloomberg Data Terminal
2012 Sub-Market Share for AutoNation
Figure 4. Company data
77%
21%
2%
Ownership Structure
Ownership (Institutional)
Ownership (Retail & Other)
Ownership (Insider)
37%
33%
29%
1%
Breakdown of 2012 Revenues
Import Domestic
Premium Luxury Corporate and other
Figure 1. Company Data
Figure 2. Bloomberg Data Terminal
29.47%
25.30%
15.60%
14.20%
8.63%
6.11%
0.69%
AN
PAG
SAH
GPI
ABG
LAD
KMX
0% 10% 20% 30%
Market Share by 2012 Revenues
4. INDUSTRY ANALYSIS AND COMPETITIVE POSITIONING
In the U.S. Retail Automobile Industry, long-term vehicle sales growth is largely dependent
on population growth, public transportation usage, and economic conditions (we determined
per capita income predominately determines the turnover rate at which owners replace their
existing vehicles.)
POPULATION GROWTH DRIVING AUTOMOBILE DEMAND MOMENTUM
U.S. Automobile demand Outlook driven by steady Population Growth
According to the Census Bureau, growth in U.S. population will increase slightly over
1% per year for the next 12 years1 Given this estimate, we can project that there will be an
additional 37 million adults in the United States from 2013 to 2025. This adult population
growth would satisfy our projections that population growth will continue to drive demand
for the U.S. Automobile Industry.
Growth in the Household Sector will continue to drive Vehicle Demand through 2025
Since 1990, the number of U.S. households has grown at a rate consistent with the
annual growth rate in adult population of approximately 1.2%. Assuming that the number
of households continues to grow at a steady rate, the number of U.S. households can be
expected to reach 137 million by 2025. Based on trends in U.S. households and holding the
assumption of 2.07 vehicles per household (see Figure 6), it is estimated that by 2025, there
will be 271 million vehicles in the United States, an increase of 30 million (or 1%
annualized) growth from 238 million in 2012. (See Appendix 5 for Vehicle Demand
Projections.)
Vehicle use will remain as the primary form of transportation for years to come.
Analyzing the U.S. households as a whole, only 53 percent of U.S. households had
access to public transportation and less than 9% use it regularly (See Figure 5). With
close to 87% of individuals in households driving or carpooling to work, the operation
of a motor vehicle still remains as the primary mode of transportation for U.S. households
collectively. According to the 2007 American Household Survey, 29% of U.S. households
were located in central cities, compared with 71% percent living in suburbs and rural areas.
26% and 19% of Households located in central cities did not own a vehicle and used public
transportation regularly, respectively.
AUTO RETAIL INDUSTRY: DEMAND DRIVEN BY MACROECONOMIC FACTORS
The automotive retail industry is sensitive to changing economic environments. Various
macroeconomic factors affect sales of new vehicles and automotive retailer’s profits. The 5
major factors we analyze are GDP growth, Interest Rate, unemployment rate, consumer
confidence, and fuel price. We ran a correlation analysis to identify the relationship between
Car sales and these factors (see Figure 7). Originally, we believe auto sales and consumers’
confidence are highly correlated. However, it surprised us when the result of their
correlation coefficient is -0.149 (see Figure 8). We believe the main reason is because
consumer's confidence is a leading index of auto sales. Generally, high consumer confidence
should lead to higher sales. From our research, the consumer confidence in automobile
continues increasing since 2008 and reaches its highest level in 2012 and 2013. We believe this
supports our assumption that auto retail sales will increase in the coming period after 2013
(See Figure 9 for Auto Sales Forecast)
The other three factors are highly related to auto sales. Especially, GDP Growth and
unemployment, with a 0.717 and -0.865 correlation coefficient with auto sales, respectively.
The continuously improving economic environment since 2008 financial crisis strongly
1 Source: U.S. Census Bureau, Population Division, “Projections of the Population by Selected Age Groups and Sex for the
United States: 2010-2050,” August 14, 2008: (NP2008-T2). Based on current U.S. Population of 314 million
Figure 7. Team estimates, Bloomberg Industry Outlook
GDP Growth 0.717
Unemployment -0.865
Gasoline Price 0.654
Prime Rate 0.585
Consumer Confidence -0.149
Auto Sales
Figure 8. Team estimates, Bloomberg Data Terminal
0
0.5
1
1.5
2
2.5
1950 1960 1970 1980 1990 2000 2010 2020
Vehicles per Household
Figure 5. U.S Census Bureau, Current; R.L. Polk
71%
Public Transportation Usage Rate
Suburban and Rural Households
City Households
Figure 6. U.S Department of Housing and Urban Development
9% Use Public
Transportation
29%
5. supports an assumption on auto retail sales expansion (See Figure 10 for Auto Sales Recovery
since the 2008 crisis.)
Developing Economy: A Driving force for Vehicle Demand
According to GDP consensus forecasts2, real GDP growth is forecasted to increase to
2.6% and 3.0% in 2014 and 2015 respectively from 1.7% in 2012 (see Appendix 6 for GDP
forecast distribution charts). In addition, the level of unemployment will remain on a
continuous drop to 6.8% in 2014 and 6.3% in 2015 (see Figure 11 for Economic Expansion
Forecast). In addition, personal wages and spending are reported to rise 0.1% and 0.4%,
respectively, both of which are a broad measure of the consumption of goods and services.
Therefore, GDP growth is forecasted to continue its increasing trend, growing at a pace of
3.0% and 2.9% in 2016 and 2017, respectively. However, we cannot rule out the potential risk
of occurrence of economic events and its impact on auto retail industry. Thus, in next sections
we will model in our valuations different economic scenarios and its impact in the company’s
stock price.
Buyers Return to New Car Market: High pent up demand will continue to drive
momentum in vehicle sales and absorb inventory levels
In terms of inventory, the number of days needed to sell a new car was on increasing
trend between 2009 and 2012; from a low of 47 days to 61 days (see Figure 12.) The high
inventory level pushes automakers to increase incentives for promotion, which in return lure
more new car buyers. Overall, supply and demand is reasonably aligned, but with units on
hand at a multiyear high, we can expect further promotions by automakers and, thus,
continued sales. The reason why days to turn slowed down is mainly because as the sales
approaching its historical level, the pent up demand due to 2008 financial crisis is being
absorbed. The forecast of sales growth in the coming few years is expected to be at 1.4%.
STRONG POSITIONING TO GAIN MARKET SHARE IN AUTO RETAIL INDUSTRY
Auto retail industry is a highly regulated and competitive industry. The total number of U.S.
franchised automotive dealerships was approximately 15,900 at the end of 2012, and the total
number of U.S. independent used vehicle dealers was approximately 37,900 in 20123.
Competitors include public companies, private companies, and online marketplaces. We
believe that the principal competitive factors in the automotive retail business are location,
service, price, and selection.
Efficient Sales Network: Key driver in a highly competitive market
AutoNation is the # 1 auto dealer in the U.S. The firm owns 265 new-vehicle franchises
in 14 states, predominantly in online sales through AutonNation.com and individual
dealer websites. Despite the fact that the largest competitor, Penske Automotive (PAG), has
more locations, its market share of auto sales is less than AutoNation’s (see Figure 13). This
indicates AutoNation is more efficient in using its sales network, which includes dealership
and online sales. Based on this market share analysis, we get HHI ratio 425.81 for Auto Retail
industry, which is much lower than the hurdle rate 1500 defined as "not concentrated". The
HHI analysis supports our assumption that the Auto Retail Industry is highly competitive.
INVESTMENT SUMMARY
Good entry point for a growth stock
We issue a BUY recommendation for AutoNation, Inc. with a target price USD 52.26 and
6.33% upside from current price level. AutoNation’s position as leader of the U.S. Retail
Automobile Industry, efficient dealership management and sound expansion strategy will
allow the company to continue gaining from the current positive market conditions. In the
last year, AN share price has increased by 16.55%, fueled primarily by continued consumer
2 GDP Consensus Forecasts consist on 77 financial firms: Including the Federal Reserve and leading financial institutions
3 Bureau of Transportation Statistics
Figure 12. Bloomberg Industry Outlook, Data Terminal
Auto Retail Industry
Market Share in 2012
Figure 13. Bloomberg Data Terminal
Figure 10. Bloomberg Data Terminal
Figure 11. Team estimates, Bloomberg Data Terminal
Figure 9. Team estimates, Bloomberg Data Terminal
0
5
10
15
20
2000 2005 2010 2015
Auto Sales Forecast
Auto Sales
Prime Rate
Consumer Confidence
6. demand for new cars. The company is expected reach pre-recession revenue levels of 18 billion
by 20174. In the past four years EPS and EBITDA has experienced significant growth, each
growing at an annualized rate of 26% and 15%, or total of 156% and 77% respectively. Even
though the stock has recently traded at a premium compared to its peers, we expect continued
growth in share price if no major economic event occurs that could potentially hinder the
current automotive industry trend.
Valuation methods
The target price was derived by applying equal weights to DCF valuation and Company
Comparable valuation. It is our opinion that both methods should not be differentiated. The
DCF valuation used was Free Cash Flow to Equity and the Company Comparable valuation
selected peer companies that reflected similar growth trends and strategies as AutoNation.
Two-Stage Growth will continue to drive shareholder value
AN has experienced a multi-year growth after the financial crisis, which has bolstered
shareholder value in the short and medium-term. The economic recovery from 2009 to the
last twelve months has driven revenues, with EPS and EBITDA growing from USD 1.12 and
461 in 2009 to 2.87 and 816 LTM, respectively. We categorize this growth as the “first stage”
phase of the two stage growth that AN will experience. Namely, the aggressive acquisition
strategy and enterprise efficiency development has allowed AN to position itself to capitalize
on the economic recovery. As the economy continues to expand and enter an expansionary
phase through the forecasted period, we project the company to enter the “second stage” of
its long-term growth phase, making the investment a good entry price at its current value.
VALUATION
The valuation process of AutoNation (AN) consists on standard approaches- The Discounted
Cash Flow (DCF) model and the Company Comparable model through relative and future
trading multiples. In our process, we will incorporate stress analysis of key assumptions of the
models to illustrate stock price volatility to changing economic conditions.
DISCOUNTED CASH FLOW VALUATION: FCFE MODEL
We are evaluating AN using the Discount Cash Flow (DCF)- Free Cash Flow to Equity (FCFE)
through the Perpetuity method as we believe this analysis is a highly suitable method to model
the company because the stability of its capital structure. We are utilizing the Free Cash Flow to
Equity approach because the firm’s leverage will not change over the forecasted period and it
has remained stable over the past five years. In addition, AN is currently in a Two-Stage growth
phase; therefore, FCFE will appropriately illustrate the present value of the future cash flows
of the company through its years of growth. According to our Discounted Cash Flow analysis,
the target price for AN is USD 50.96. The DCF is driven by the following fundamental factors:
Sales Forecast
The five-year forecasted free cash flows are driven by sales and we identified through our
correlation analysis that the strong relationship of .717 between GDP growth to vehicle sales
serves a key determinant to AN’s total revenue projections. Given the company’s growth
phase, overall economic cycle, and leading consumer confidence levels, it is suitable to utilize
a two-stage growth model approach to forecasting sales. As a result, AN will likely sustain a
robust sales growth during the years of 2014-2016, albeit more stabilized by the terminal year
of 2017 (see Figure 16) The forecasted sales is derived from the product of the consensus on
GDP growth for the forecasted period and the correlation to auto sales and should serve as a
very conservative estimate of AN’s sales growth. (See Appendix 2 for Income Statement
Forecast)
4 According to Team estimates
Figure 16. Team estimates
AutoNation Sales Forecast
2014E 2015E 2016E 2017E
Revenue 16,663 17,010 17,376 17,737
Finance Division 665 679 694 708
Other Revenue 159 162 165 169
GDP Correlation 0.717 0.717 0.717 0.717
Consensus GDP Forecast 2.64% 2.90% 3.00% 3%
Target Growth Rate % 1.90% 2.10% 2.20% 2.10%
Total Forecasted Revenue 17,487 17,851 18,235 18,614
Figure 14. Company Data and Team estimates
40.62
38.95
57.92
45.83
72.43
49.10
62.36
61.30
30 40 50 60 70 80
P/E
EV/EBITDA
EV/TREV
Mean Price
Peer Valuation Ranges
Figure 15. Company Data and Team estimates
7. Capital Expenditures (CAPEX)
AN’s CAPEX for 2013 are expected to be 145 million5. To forecast CAPEX for 2014-2017
and beyond, we assumed an annualized growth rate of 6.1%, derived from an average 3-year
CAGR from historical capital expenditures. AN is likely to continue growing its capital
expenditure as it invests heavily in transforming its IT infrastructure to develop a more
engaging online experience for its end-customer.
Capital Asset Pricing Model: Cost of Equity
The cost of equity was calculated using the CAPM. We used the 10-year US Government
Bond Yield of 2.95% as risk-free rate. The beta was calculated by the correlation between
AN and the market, for which we used S&P 500 returns as a market proxy (see Appendix 7
for Beta Calculations) which yielded a beta for AN of 1.0702, which we have determined to
remain relatively stable due to the maturity of the automotive market. The expected market
return of 10.60% used is derived from analyst consensus of the S&P 500 expected returns.
Five-Year Cash Flow Assumptions
In order to obtain change in NWC, Current Assets were forecasted with a growth rate of
4.34% by using a 3-year CAGR and applied an expected ratio of Current Assets to change in
NWC of 11.1% derived from historical averages. Proceeds from New Debt Issuance were
forecasted using a 3-year CAGR average which yielded a growth rate of 11.71%. For
Repayout of Debt, we used a historical 1.25 New Debt Issuance to Repayout of Debt Ratio.
(See Appendix 8 for DCF Calculations)
Residual Growth Rate
Residual growth rate of 2% is based primarily economic analysts’ consensus for long-term
US Inflation rate of 2%. We performed a Monte Carlo simulation in order to test to what
extent AN’s stock price will be affected by a change in the US Inflation rate, setting a floor
of 1% and a ceiling of 3%. To further test different scenarios, additional variables were
included in the simulation, such as CAPEX and Proceeds from New Debt Issuance growth
rates. The mean price obtained was USD 51.19, which is relatively close to the DCF FCFE
estimate of USD 50.96, and still yields a BUY recommendation. (See Figure 18 and Appendix
9 for Monte Carlo Simulation results).
COMPANY COMPARABLE VALUATION: P/E, EV/EBITDA, EV/TREV
In analyzing AN through the Company Comparable Valuation method we arrived to a target
price of USD 53.56, with a high of 61.3 and a low of 45.83 by comparing the values assessed
by the market for AN’s comparable industry peers. We identified the peer universe by
analyzing the industry where the subject company mainly operated and obtained a narrow
peer group derived from the last twelve month’s total revenues from each firm. We have
applied the median multiplier from all peers to derive to AN’s implied share price. Our
multiplier analysis indicates that AN’s EV/Total Revenue has historically traded at a
premium from its peers, with an average premium of 66%. In terms of P/E and
EV/EBITDA the multiples have also traded at historical premiums, albeit much lower at an
average premium of 26% and 17% respectively (see Figure 19 and Appendix 10 for Peer
Multiplier Analysis.)
The reasoning behind the premium in multiples, especially EV/Total Revenue, can be
attributed to the stronger and more efficient revenue generation through the sales channels
of the company and we believe the trend will continue as the company makes strategic
acquisitions and strengthens its network. As a result, we have applied the historical premium
to the median industry multiples to assess the implied value of AN. (See Appendix 11 for
Company Comparable Valuation)
5 According to the company’s Q3 2013 Quarterly Earnings Report
Figure 17. Bloomberg Data Terminal and Team estimates
Figure 19. Team Estimates
Figure 18. Team Estimates
8. FINANCIAL ANALYSIS
AutoNation (AN) enjoys from an effective and efficient business model with strong
operational metrics and an improving balance sheet. AN generates above-industry revenues
due to its efficient sales network and lean cost structure. We have developed a ranking model
to assess AN’s operational, solvency, and liquidity ratios to benchmark the company against
its peers6. We have issued AN a ranking of “Average” in terms of overall company health. The
factors that drive our analysis include:
Operating Metrics: An efficient business model and large sales network results in high
asset and inventory turnover ratios, which has allowed AN to capture the largest new
vehicle market share and will continue to position the company to capitalize on vehicle
sales in the forecasted period. We have ranked AN’s operational performance as “Above
Average” within the industry
Solvency Metrics: AN’s focus on effective capital allocation strategy has allowed the
company to make strategic acquisitions that have positioned the company to heavily
capitalize from periods of economic expansion and enable AN to continue to maximize
shareholder value. Although the company has seen continued development on solvency,
AN’s capital structure is composed of a high level of debt. As such, we have issued an
“Average” ranking within the industry
Liquidity Metrics: Although AN has an investment-grade balance sheet is continues to see
a developing trend after the culmination of the aggressive acquisition strategy since 2007.
We believe solvency and liquidity will be one of the most challenging factors that AN’s
management will encounter in the forecasted period. As a result, we have issued an
“Average” ranking among all other peers in the industry.
OPERATIONAL METRICS: TOP PERFORMER IN THE AUTOMOBILE INDUSTRY
Multi-Year Revenue Recovery: Aggressive Acquisition Strategy drives sales growth
Following the backlash in industry-wide sales in 2008, AN experienced surging revenue growth
in addition to the factor attributable to overall economic development. As a result of the M&A
environment, AN strategically positioned itself to capitalize from a developing economy, as it
increased its market share and product offering throughout the nation (see Figure 20 for Effect
of Acquisitions on Sales Growth). The increase in its store portfolio, particularly in 2007,
allowed AN to outperform its industry peers in terms of total revenue. With the total number
of acquisitions made by AN accounting to 19 from 2007 to 2013 culminating with the
acquisition of O’Hare Honda & O’Hare Hyundai Vehicle dealerships which are expected to
generate annual revenues of USD 85 million7, we see the multi-year trend in sales recovery to
sustain as the economy continues to expand in the forecasted period. (See Appendix 12 for
AutoNation’s M&A Timeline)
SOLVENCY METRICS: CONTINUED RECOVERY FOLLOWING AGGRESSIVE
ENTERPRISE TRANSFORMATION
Lean Cost Structure: Increase in Productivity will push down SG&A, improve margins,
and create Synergy among stores
AN’s management has developed a very lean cost structure, with SG&A decreasing at
a faster rate than total revenues. The decrease in its cost structure is attributed to the
company’s development of its online portal, which will increase associate productivity
and efficiency and reduce general and administrative costs of doing business from store to
store. Management developed this lean and flexible business model as a result of the backlash
from the financial crisis, in order to decrease costs and increase productivity. The online portal
will result in increased synergies among old and newly acquired stores, which will continue to
drive same store sales. Therefore, as SG&A expenses continue to be pushed down in the
6 Analysis Based on ratios benchmarked against industry peers. See Appendix 13 for Scoring Methodology
7 Source: Company Q3 2013 Quarter Earnings Call
Figure 20. Team estimates
Figure 21. Team estimates
Figure 22. Team estimates
9. 52.0
54.0
56.0
58.0
60.0
62.0
64.0
66.0
68.0
0
1.0
2.0
3.0
4.0
5.0
6.0
7.0
8.0
2008 2009 2010 2011 2012 LTM
Cash Generation Efficiency
Avg. Days Sales Out.
Avg. Days Payable Out.
Avg. Days Inventory Out.
Avg. Cash Conversion Cycle
future, the online portal will allow AN to further penetrate the market and the effect will result
in higher profit margins (See Figure 22 for Effect of Cost Structure on Margins.)
High Efficiency Performance: Increase in Inventory turnover and cash conversion
cycles improve Balance Sheet
AN’s focus on growth through expansions and enterprise-wide efficiency will continue to
develop the overall financial condition. Through the expanded sales network, AN has
capitalized on the overall economic expansion. Combined with the increased productivity,
average days to sell inventory has decreased from 66.7 days in 2008 to 58.6 days in the last
twelve months (see Figure 23 for Cash Generation Efficiency). The improved inventory
turnover level has decreased the cash conversion cycle, which in turn has driven the cash
position and developed overall liquidity. As the economy develops in the forecasted period we
believe AN will be particularly well-positioned to continue improving its average days to sell
and conversion cycles, which will continue to improve the balance sheet, the ability to service
current debt, and boost short-term liquidity.
INVESTMENT RISK & SCENARIO ANALYSIS
SYSTEMATIC RISK
Highly Sensitive to Macroeconomic Factors
An economic slowdown may potentially affect all business segments severely. This is not
likely to happen within the next 3 year span according to our findings and analysts’
consensus as GDP growth continues to increase, unemployment continues to decrease, and
other key indicators continue to signal robust economic growth. (See Figure 24 Net Income
Sensitivity to changes in GDP).
Disruptive Events
Events such as the previous earthquake in Japan or the recent Government shutdown could
negatively affect all segments revenue streams by disrupting supply or demand trends.
OPERATIONAL AND FINANCIAL RISK
Management Effectiveness
Crucial factor in order to prevent a potential downgrade by Moody’s if debt/EBITDA were
to rise above 4x, or if EBIT/interest expense fell below 5x. The recent news of CFO Mike
Short stepping down may lead to some instability that may be reflected in the stock price,
depending on who is chosen as his replacement. Cheryl Scully, who’s served as Vice
President and Treasurer for the company for over four years, has stepped up as interim CFO
while the Company conducts a search for a new candidate.
Legal Proceedings
Legal contingency expenses have been mostly accrued and hedged for, but unfavorable
results could severely affect the bottom line. They occur frequently, which is normal for
corporations of that magnitude who deal with ongoing labor disputes of all matters.
ENVIRONMENTAL RISK
Highly Competitive Environment
The fast growing number of competitors could potentially decrease future market share.
Also, there is a potential weakness in the import segment due to competitors’ volume-based
incentives. AutoNation’s new centralized Branding Strategy will help hedge this risk along
with its current competitive advantage. This environment may also lead to increasing prices,
which in turn may limit growth through Mergers and Acquisitions in the future.
Figure 24. Team estimates
Figure 23. Team estimates
10. REGULATORY RISK
Government Regulations
Are going currently through changes which could affect the competitive advantage held by
AN. Specifically The Dodd-Frank Wall Street Reform and Consumer Protection Act may
lead to additional and indirect regulation of automotive dealers, in particular, their sale and
marketing of finance and insurance products, through its regulation of automotive finance
companies and other financial institutions. In the Q3 Earnings Call AutoNation ensured the
threat was hedged to its shareholders ensuring a minimal impact but still leaving a small
room of uncertainty.
Source: Team estimates
Overall AutoNation is well positioned in terms of investment risk
As its exposure to severe risk is well hedged and limited; this is seen below in the risk Matrix,
which rates the risks AutoNation will be facing in terms of exposure and severity in the
upcoming years, as its leaning towards the bottom left (Green) indicating its strength.
5
4
Catastrophic
Disruptive Events
Economic
Slowdown
3
Loss of Market
Share
2
New
Government
Regulations
Legal Disputes
Increasing
Competitive
Environment
1
Management
Effectiveness
New
Technological
Trends
1 2 3 4 5
S
e
v
e
r
i
t
y
Exposure
Investment Risk Matrix
18. 17
Appendix 8: DCF Calculations
Source: Team estimates
2013F 2014F 2015F 2016F 2017F Residual
Risk Free Rate (10-yr Tbonds) 2.95% 2.95% 2.95% 2.95% 2.95% 2.95%
Market Risk (S&P 500) 10.60% 10.60% 10.60% 10.60% 10.60% 10.60%
Beta 1.0702 1.0702 1.0702 1.0702 1.0702 1.0702
Cost of Equity (CAPM) 11.14% 11.14% 11.14% 11.14% 11.14% 11.14%
Discounted Cash Flow 2013F 2014F 2015F 2016F 2017F Residual
Net Income 348.7 291.0 328.8 351.5 361.4 361.4
D&A 92.5 107.0 108.5 107.5 108.9 108.9
Capital Expenditure 145.0 153.8 163.2 173.2 183.8 183.8
Change in NWC 198.95 31.49 35.58 38.04 39.11 39.11
Proceeds from New Debt Issuance 1,112.60 1,242.89 1,388.43 1,551.01 1,732.64 1,732.64
Repayout of Debt 890.08 994.31 1,110.74 1,240.81 1,386.11 1,386.11
FCFE 319.77 461.26 516.20 557.98 594.01 594.01
PV of FCFE 319.77 415.03 417.90 406.44 389.31
Terminal Growth Rate 2.00%
Perpetuity Cost of Equity 11.14%
Residual Value 6,498.08
PV of Residual Value 4,258.76
PV of FCFE 1,948.43
Value of Equity 6,207.19
Number of Shares Outstanding (in mm) 121.81
Current Share Price as of Jan. 6, 2013 48.91
Implied per Share Value 50.96
19. 18
Appendix 9: Monte Carlo Simulation
Source: Team Estimates
Known Inputs
Discount Rate 11.14%
Historical Debt Issuance to Repayout Ratio 1.25
Number of Shares Outstanding 121.81
CAPEX for 2013 145.00
Proceeds from New Debt Issuance 1,112.60
Uncertain Inputs
Distribution Parameter 1 Paramenter 2 Parameter 3
Terminal Growth Rate 2% Triangular 1% 2% 3%
Distribution Mean Std. Deviation
Capital Expenditure Growth 6.10% Normal 6.10% 5.00%
Proceeds from New Debt Issuance Growth 11.71% Normal 11.71% 5.00%
Parameters of Distributions
Minimum 33.10
Maximum 76.31
Mean 51.19
10th percentile 42.58
90th percentile 58.19
Monte Carlo Simulation Summary Statistics
21. 20
Appendix 11: Company Comparable Valuation
Source: Team estimates
P/E LTM 2014E
AN EPS 2.87 2.40
AN P/E 19.02x 16.95x
Target AN P/E Price 54.61 40.62
Peer Median EPS 3.22 4.01
Peer Median P/E 17.85x 14.08x
Target P/E Price from Industry Peers 57.49 56.46
Historical Premium 26% 26%
Target AN P/E Price @ Historical Premium from Peers 72.43 71.14
Low Range 40.62
Midpoint 56.52
High Range 72.43
EV/EBITDA LTM 2014E
Peers Median EV/EBITDA 11.61x 11.15x
EBITDA 816.9 791.3
Cash & ST Investments 68.3 150.4
Debt 4457.2 4928.1
Equity Value (USD) 5097.7 4043.9
Shares Outstanding 121.5 121.5
Target EV/EBITDA Price from Industry Peers 41.97 33.29
Historical Premium 17% 17%
Target AN EV/EBITDA Price @ Historical Premium from Peers 49.10 38.95
Low Range 38.95
Midpoint 44.02
High Range 49.10
EV/Total Revenue LTM 2014E
Peers Median EV/Total Revenue 0.52151 0.515655
Total Revenue 17,167 17,487
Cash & ST Investments 68.3 150.4
Debt 4457.2 4928.1
Equity Value (USD) 4,563.97 4,239.69
Shares Outstanding 121.5 121.5
Target EV/Total Revenue Price from Industry Peers 37.56 34.89
Historical Premium 66% 66%
Target AN EV/TREV Price @ Historical Premium from Peers 62.36 57.92
Low Range 57.92
Midpoint 60.14
High Range 62.36
22. 21
Appendix 12: AutoNation’s M&A Timeline
Source: Company Data
Timeline of AutoNation's Acquisitions
2007 2008 2009 2010 2011 2012 2013
Don Mackey
BMW
Collier
Lincoln
Mercury, LLC
Team
Hyundai Mall
of Georgia
Templeton
Family, Inc.
Boardwalk
Auto Group
Mize Import
Group, Inc
King Motor
Company Of
Fort
Lauderdale
Team Toyota
Mall of
Georgia
Boardwalk
Audi
O'Hare
Honda &
Vehicle
Dealerships
Pontiac
Franchise
Boardwalk
Porsche and
Boardwalk
Volkswagen
Store in
Dallas
SanTan
Honda
Superstore
Buick
Franchise
Spring
Chrysler Jeep
Dodge
Hyundai Of
Tempe, LLC
GMC
Franchise
Don Davis
Auto Group
Saturn
Franchise
Acquisitions 6 1 0 2 1 4 5
Total
Acquisitions 19
23. 22
Appendix 13: Financial Analysis Scoring Methodology
Operational Metrics
Solvency Metrics
Liquidity Metrics
Conclusion
Source: S&P Capital IQ and Team Estimates
Weight
Metric Score AN Peer Mean AN Peer Mean AN Peer Mean AN Peer Mean AN Peer Mean
3.0% Total Revenue 1 10,666.0 8,401.34 12,461.0 9,861.07 13,832.3 11,346.14 15,668.8 11,946.8 17,167.2 12,631.08
3.0% Total Equity 2 2,303.2 1,568.92 2,078.9 1,784.65 1,894.6 1,566.9 1,688.5 1,782.9 1,993.4 1,918.99
3.0% Return on Capital (%) 4 8.0 6.65 9.28 12.53 10.37 15.47 10.13 14.1 11.05 14.42
3.0% Recurring Earnings/Total Assets (%) 2 7.12 6.5 8.27 8.29 9.21 9.73 9.02 9.38 9.82 9.78
3.0% Net Working Capital/Revenue (x) 1 0.15x 0.11x 0.16x 0.11x 0.15x 0.1x 0.17x 0.12x 0.15x 0.11x
3.0% Asset Turnover (x) 2 1.97x 2.01x 2.09x 1.97x 2.23x 2.13x 2.18x 2.03x 2.33x 2.06x
3.0% Net Working Capital/Total Assets (x) 2 0.3x 0.25x 0.34x 0.23x 0.33x 0.24x 0.37x 0.27x 0.36x 0.26x
3.0% Payables/Receivables (x) 3 0.82x 0.94x 0.77x 0.97x 0.88x 1.21x 0.93x 1.2x 0.98x 1.46x
3.0% Management Rate of Return (%) 4 11.58 8.22 12.84 26.82 14.31 29.5 13.67 23.91 15.01 23.14
3.0% Gross Margin (%) 2 17.91 13.97 17.07 15.46 16.66 15.24 15.87 14.91 15.67 14.96
3.0% EBITDA Margin (%) 4 4.33 4.08 4.58 6.14 4.73 6.35 4.71 6.4 4.76 6.63
33.3% Overall Operational Ranking 2
2009 2010 2011 2012 LTM
Weight
Metric Score AN Peer Mean AN Peer Mean AN Peer Mean AN Peer Mean AN Peer Mean9
4.76% FFO Interest Coverage (x) 2 4.35 0.51 2.5 5.83 3.46 4.38 2.4 0.67 3.34 2.01
4.76% EBITDA/Interest Exp. (x) 4 5.9 3.91 5.79 11.28 6.02 10.11 5.57 9.91 5.83 10.41
4.76% FFO to Total Debt (x) 3 0.14 0.12 0.08 0.53 0.11 0.26 0.07 0.21 0.11 0.21
4.76% Net Debt/EBITDA (x) 4 5.01 5.25 5.47 5.26 5.29 4.31 6.19 4.56 5.37 3.94
4.76% Total Debt to Capital (%) 4 51.66 52.31 60.44 55.22 64.44 58.09 72.28 59.25 67.99 58.89
4.76% Total Debt/Total Liabilities (%) 1 80.13 55.73 82.54 59.62 82.38 61.04 84.07 61.67 82.83 62.46
4.76% Total Debt/Revenue (x) 3 0.23 0.19 0.26 0.22 0.26 0.21 0.3 0.23 0.26 0.24
33.3% Overall Operational Ranking 3
2009 2010 2011 2012 LTM
Weight
Metric Score AN Peer Mean AN Peer Mean AN Peer Mean AN Peer Mean AN Peer Mean
8.30% (FFO + Cash) to Short Term Debt (x) 2 0.37 7.25 0.18 57.72 0.24 5.94 0.15 5.69 0.2 6.52
8.30% FFO to Gross Profit (x) 3 0.18 0.15 0.12 0.22 0.16 0.2 0.13 0.12 0.17 0.19
8.30% Current Ratio (x) 4 1.22 1.53 1.1 1.47 1.09 1.43 1.05 1.45 1.02 1.45
8.30% Quick Ratio (x) 4 0.31 0.71 0.23 0.59 0.27 0.6 0.24 0.56 0.2 0.57
33.2% Overall Operational Ranking 3
2009 2010 2011 2012 LTM
Company Financial Condition
Overall Score
Average
Operational Above Average
Solvency Average
Liquidity Average
Financial Category Score
25. Disclosures:
Ownership and material conflicts of interest:
The author(s), or a member of their household, of this report does not hold a financial interest in the securities of this company.
The author(s), or a member of their household, of this report does not know of the existence of any conflicts of interest that might bias
the content or publication of this report.
Receipt of compensation:
Compensation of the author(s) of this report is not based on investment banking revenue.
Position as a officer or director:
The author(s), or a member of their household, does not serve as an officer, director or advisory board member of the subject
company.
Market making:
The author(s) does not act as a market maker in the subject company’s securities.
Disclaimer:
The information set forth herein has been obtained or derived from sources generally available to the public and believed by the
author(s) to be reliable, but the author(s) does not make any representation or warranty, express or implied, as to its accuracy or
completeness. The information is not intended to be used as the basis of any investment decisions by any person or entity. This
information does not constitute investment advice, nor is it an offer or a solicitation of an offer to buy or sell any security. This report
should not be considered to be a recommendation by any individual affiliated with CFA societies Florida, CFA Institute or the CFA
Institute Research Challenge with regard to this company’s stock.
CFA Institute Research Challenge
![Florida International University Student Research
This report is published for educational purposes only by students
competing in the CFA Institute Research Challenge.
[Automotive Retail, Consumer Discretionary Sector]
Date: 01/09/2014 Current Price: USD 49.00 Recommendation: BUY
Ticker: AN:NYSE Target Price: USD 52.26
HIGHLIGHTS
Good Point of Entry: We issue a BUY recommendation for AN with a target price of
52.36 and a holding period return of 6.65%. AN is expected to reach the target implied
share price by the second quarter of 2014, an implied return of 6.65%. AutoNation is the
strongest revenue generator in the automotive retail industry, with a market share in new
vehicle sales of 29.7%. The company is in a two-stage growth trend and it has experienced the
“first-stage” phase in the past 3 years. The significant growth, which has added value to the
shareholder, with EPS growing from USD 1.12 to 2.87 in the last twelve months for a total of
156% or 26% annualized will continue as the company enters the “second-stage” in the
forecasted period.
Strong Revenues: Strategic acquisitions, a highly effective management, and strong
competitive advantage has positioned AN to capitalize from the economic recovery.
The larger sales network of AutoNation has propelled continuous growth in new vehicle
market and allowed to capture tremendous growth from positive industry and macroeconomic
trends, with EBITDA growing from USD 461 million to 816.9 million, or 77% (or 15%
annualized) since 2009. As a result, AN has enjoyed strong revenue growth after the financial
crisis, with revenues growing 29.7%, from USD 13 million in 2008 to 17 million in the last
twelve months, or at a compound annual rate of growth of 5.3%. The company is currently in
the “first stage” of a two-stage growth trend
Key Revenue growth drivers: A Highly Effective Business Model with Strong
Operational Metrics
The development and implementation of an enterprise information system will increase
productivity and overall efficiency. The introduction of an online web portal will create
synergies among stores and add value to the selling channels. As a result, AN will be
strategically positioned to capture demand from the forecasted economic expansion
Large distribution channels through the acquisition of 19 companies in the past 4 years
have significantly increased market penetration and brand positioning. As AN develops the
brand further, the company will be able to retain repeat consumers and capture new
consumer entrants
Investment Risks: The main risks AN faces are from fluctuations in economic conditions,
solvency, and short-term liquidity. The high level of debt taken on by the firm in its expansion
efforts poses challenges if combined with an economic slowdown.
52-week Price
Range
40.30 - 54.49
Average Daily
Volume
880 540
As % of shares
outstanding
0.72%
Altman's
Z-Score
4.56
2013 Dividend
Yield
-
Shares
Outstanding
121 810 000
Market
Capitalization
5.99 B
Insiders
Holdings
47.33%
BV per Share 16.37
ROE 2013E 12.4%
Debt to Capital
2013E
66.41%
P/BV 3.04
P/E 17.39
Market Profile
AutoNation daily stock prices
Valuation DCF
Company
Comparables
Estimated
Price
50.96 53.56
Weights 50% 50%
Target
Price
52.26
Source: Team estimates
Source: Bloomberg
Source: S&P Capital IQ
AutoNation, Inc.](data:image/gif;base64,R0lGODlhAQABAIAAAAAAAP///yH5BAEAAAAALAAAAAABAAEAAAIBRAA7)