AutoNation (NYSE: AN) is a fascinating company in a precarious situation. It is trying to bring rationality to American auto sales by introducing standard retail practices to the sector.
That bold experiment has produced a very uneven set of financial numbers that show a company either poised to break out into the retail big leagues or collapse. Like a number of retailers, such as Dollar General (NYSE: DG), AutoNation has created a business model that produces a great deal of revenue, but generates very little cash.
AutoNation did display some very impressive revenue growth in 2015. It entered the year with $19.11 billion in December 2014 and finished it with $20.86 billion in December 2015. Actually, 2015 marked only the latest year in which AutoNation’s revenues grew dramatically. This pattern has been repeating itself for a number of years.
In December 2011, AutoNation reported $13.83 billion in revenue that grew to $15.67 billion in December 2012. That figure increased to $17.52 billion in December 2013 and $19.11 billion in December 2014. As you can see, AutoNation’s revenue growth could be slowing a little, but it has remained steady for a few years.
Does AutoNation Make Money?
The revenue figures seem to justify AutoNation’s business model, but does it make money? The answer unfortunately seems to be no, despite the revenue growth, AutoNation actually seems to be losing money.
The company reported a free cash flow of -$36.2 million for the fourth quarter of 2015. It also reported a net income of $442.6 million for the same period. What’s even more bothersome is that AutoNation does not have that much cash.
It generated just $507.2 million in cash from operations and $90 million in cash from financing, which seems low with all the cars it finances. To make matters worse, the company had only $74.1 million in cash and short-term investments.
AutoNation could Collapse at Any Moment
These figures show us that AutoNation could collapse into the death spiral very quickly. It simply has no additional cash to sustain its operations if the volume of auto purchases collapses suddenly.
That might not be a problem right now because U.S. auto sales are great. Forbes reported that American car buying hit a 15-year high in February 2016. Auto purchases were at their highest level in 15 years since 2001. The sales figures for February 2016 were actually 8% higher than in January.
The problem is that this burst in sales activity may not be sustainable. It is being driven by pent-up demand; large numbers of Americans have not bought a new vehicle in years because of the economic meltdown of 2007-2009. Outside factors, such as low interest rates and incentives, are also driving sales.
Are Auto Sales a Bubble?
AutoNation’s own CEO, Mike Jackson, cast serious doubt on the sales figures in a CNBC interview on March 15, 2016. Jackson thinks that sales volume is being artificially propped up by incentives and deals on leases.
“All those are yellow flags that you’re starting to take steps to try to sustain a sales volume that really isn’t there,” Jackson admitted. He noted that incentive spending at dealers is now 14% higher than it was last year.
Despite that, revenues should remain high in the short term because of strong sales for high-margin vehicles, mostly pickup trucks, Jackson thinks. Yet he is skeptical of dealers’ long-term prospects, which indicates that vehicle sales could be in a bubble.
Part of that bubble could be leasing: Jackson noted that leasing now accounts for 30% of car sales, Auto News reported. That means dealers could be faced with large numbers of lease returns if a major economic downturn occurs. So, yes, auto sales are a bubble that could burst any moment.
AutoNation is not a Value Investment
This means that AutoNation is not a value investment because it simply lacks the cash to sustain its current share price, yet investors might be wondering if the company is a viable growth stock.
To answer that important question, I’ll perform a short Strengths, Weaknesses, Opportunities, and Threats (or SWOT) analysis.
Quick and Dirty AutoNation SWOT Analysis
Strengths – Large dealership networks over 290 franchises nationwide with a satisfied customer base of 100,000 people. The company has demonstrated the ability to quickly adapt to the changing industry. High level of customer service generates customer loyalty. Its sheer size could help it avoid an auto industry downturn.
Weaknesses – The company has a limited amount of cash on hand, which could make it difficult to survive a sudden drop in sales or an economic downturn. It is increasingly reliant on leases, incentives, and financing deals to generate sales. The market for new vehicles could be limited, particularly with income inequality and wage stagnation lowering the buying power of average Americans.
Opportunities – Growing consolidation in the auto sales segment favors AutoNation’s business model. The increased demand for new vehicles with new features, such as electric drive trains, self-driving capabilities, and all-new drive spurs sales. Today’s auto buyers are also more likely to respond to incentives and lease deals that only larger organizations such as AutoNation can provide. Growing segments of the public are unwilling to work with traditional auto dealers whom they dislike and distrust.
Threats – The decline in vehicle ownership and the percentage of Americans who drive could cut into the demand for new cars at some point. Growing income inequality and wage stagnation means that there are fewer people with the ability to lease or finance a new vehicle. Interest rates could rise at any time and limit the financing incentives AutoNation relies upon. Another long-term threat is the rise of alternative vehicle sales channels, including online sales and the growing popularity of auto brokers who work outside dealerships.
Based upon these factors, I would surmise that AutoNation’s current rate of revenue growth is unsustainable. It is likely to end soon, and when it does, it’ll drag the company’s stock value down with it. I’d advise investors to stay away from AutoNation, and car dealership stocks in general, because the current boom in auto sales is unsustainable. Expect to see a major collapse in this sector in the near future.