Asbury Automotive

Asbury Automotive Group's second-quarter same-store revenue declined 6.6% year over year, with all segments down except for service, which increased about 1%. Management said the firmwide conversion to the Tekion dealer management system is 70% complete and will finish in October.

Why it matters: Despite a decline in new-vehicle industry sales, we think Asbury had a solid quarter, with an adjusted operating margin, including floorplan interest expense, of 4.8%, down 60 basis points but still above the low-4 % levels of 2019. Service is, in our view, an overlooked yet critical aspect of a dealer's business as it provides about half of a firm's total gross profit. It also helps weather the cyclicality of new and used vehicle sales. Dealers don't just make money selling vehicles. Service, finance, and other products greatly matter. Third-quarter overhead costs will have more Tekion conversion than normal as the conversion pushes for completion, but management expects overhead costs as a percent of gross profit to decline every quarter into 2027 via more salesperson productivity and adjusting service labor rates.

The bottom line: We are increasing our fair value estimate for narrow-moat Asbury to $315 from $312, reflecting the time value of money. We see the Tekion conversion setting the company up to have some of the best overhead cost leverage of the six public franchise auto dealers, and Asbury is already a leader. Management is focusing on maximizing volume but only to the point of keeping healthy gross profit per unit, which we like as it can keep service units in operation up for the store base. Focusing solely on volume would lead to undesirable declines in gross profit. Net debt of 3.4 times adjusted EBITDA remains above the target of 2.5-3.0 times. Management expects to reach that level by mid-2027, but for the quarter chose to focus on buybacks over debt reduction due to the compelling value of the stock, which we don't mind in the short term.

Our Asbury per-share fair value estimate is $315, up from $312, reflecting the time value of money. Our midcycle operating margin, including floorplan interest expense, remains about 5%. We still consider Asbury one of the top dealer operators in our coverage and believe its growth runway to $30 billion in annual revenue over the next decade is possible, given the sector's highly fragmented nature and Asbury’s access to capital.

Management announced in early 2024 that it is withdrawing its 2025 revenue target of $32 billion and instead targeting at least $30 billion sometime during 2025-30. Given Asbury’s continued ambition to grow from acquisitions, organically, and Clicklane, and because the dealer space is highly fragmented, we believed then-CEO David Hult when he said on the February 2024 earnings call that reaching $30 billion is a question of when Asbury gets there rather than if it gets there. However, we don't model $30 billion during our five-year explicit forecast period. We model about $24 billion in 2030, reflecting current macroeconomic uncertainty. We will increase this figure if more large deals are announced.

We model about $6 billion in cumulative acquired revenue for 2026-30. If $6 billion proves incorrect, it would, in our view, likely be too low rather than too high. We model total revenue across 2026-30 of about $104 billion. In December 2020, Asbury unveiled its new omnichannel shopping platform for new and used vehicles called Clicklane, which should also help top-line growth. We model a compound annual revenue growth rate for 2026-30 of about 6%. The Larry H. Miller deal offers excellent cost-scaling potential due to its size, and the captive financing product, Total Care Auto, delivers 20% or higher EBITDA margins, far better than Asbury's mid- to high-single-digit levels. TCA is in all stores except for recently acquired ones, like Herb Chambers (where it will be fully deployed by year-end 2026), so there is upside margin potential for Asbury over time, in our opinion, as TCA's deferred revenue grows and then is realized into profit over the life of the contract.

Our midcycle operating margin, including floor plan interest, of about 5% reflects our expectation of a margin ranging from under 4% in bad times to nearly 6% in good times. Asbury tends to have one of the lowest selling, general, and administrative expenses as a percentage of gross profit ratios in the dealer sector, so it is a top operator. Pricing discounts are hurting gross dollar profit per unit for both new and used vehicles, and competition and factory rules mean a dealer can sell a vehicle for only so much; thus, management must remain vigilant on leveraging SG&A to keep its SG&A/gross profit ratio low.

We model average annual operating margin including floorplan interest of about 4.8%. We think capital expenditures will average about 1.4% of sales during our explicit forecast period. We model additional acquisitions throughout this forecast period, with annual revenue acquired of about $1 billion-$2 billion every year. Our weighted average cost of capital is about 8%.

We are maintaining our narrow moat rating for Asbury, as its size continues to generate economies of scale and working-capital efficiencies, while the service segment and its warranty work give the company an intangible advantage over garages. We think the dealer sector is the best business in the automotive supply chain. Public dealers can centralize back-office operations and generate far more volume than small dealers, which brings scale. Asbury is moving to a cloud-based dealer management system from Tekion to increase productivity and gross profit, which will further help reduce overhead costs. This initiative will finish in fall 2026. Dealers have no burdensome retiree expenses, and large public dealers are not dependent on the health of a single brand. The dealers enjoy mid- to high-single-digit gross margins on new vehicles and 100% gross margin on financing and insurance. We think that the best source of competitive advantage is the parts and service operations. Many customers bring their vehicles to the dealer for service either because the vehicle is under warranty or because the dealer is close to home and has factory parts and expertise to service it. Once vehicle owners know a dealer, we think they are likely to keep going back for service. The dealer knows the vehicle, and comparison shopping for repair work is very time-consuming because the customer has to take the vehicle to each shop to get a quote.

These logistics create inelasticity of demand, which confers pricing power on the dealer and is a source of strong profits in good times and bad. In fact, during a downturn in new vehicle sales, dealers generally report higher gross margins due to a favorable mix shift, but lower operating margins due to deleverage in selling, general, and administrative expenses. Excluding large impairment and restructuring charges, dealers can still report positive EBIT even in a severe recession. Although most dealerships are good businesses, we think the large publicly traded dealers are best-positioned for growth because these firms can be the most flexible in changing brand mix. Many small-business owners are choosing to exit or sell because they cannot get the scale on a variety of expenses compared with large dealer groups. Asbury is one of the largest dealers in the US, yet it has only about 1.1% of the new-vehicle market share. About 91% of dealer owners own between one and five stores, per the National Automobile Dealers Association, and we expect this ratio to keep declining over time, so we see a long growth runway for consolidators such as Asbury.

The firm's product mix, weighted toward import and luxury brands, brings more affluent consumers to the dealership, which partially mitigates the sales decline during cyclical downturns that auto sales typically experience. Most Clicklane digital customers are also of a higher credit quality and wealth than the company had in the past.

Auto dealerships are moaty businesses that can maintain a narrow range of operating margins regardless of economic conditions.

Sizable dealership companies enjoy economies of scale, albeit limited ones.

The company is switching all its stores to a new dealer management system from Tekion that could bring a hard learning curve for a few months and hurt near-term expense leverage but probably help long-term expense leverage.

Overpaying for acquisitions is a risk and can lead to value destruction for investors.

Unlike some dealers, Asbury does not have many stand-alone used-vehicle stores because its Q auto stand-alone used-vehicle store experiment failed. A robust digital shopping tool in Clicklane should still enable good used-vehicle growth, in our view.