Lithia Motors

Lithia's stock rose about 20% intraday on July 29 after the company reported adjusted second-quarter diluted earnings per share up 9% year over year to $10.03, well above the $8.78 LSEG consensus. The company also raised its quarterly dividend by 23% to $0.70 per share.

Why it matters: We found Lithia's results to be impressive in light of same-store revenue down 1.6%, though the prior-year quarter was a tough comparable due to a sales surge last year to avoid tariffs. Adjusted overhead cost as a percentage of gross profit fell 290 basis points from the first quarter. The captive finance arm, Driveway Finance Corp., posted record segment income of $36.5 million and financed 18% of Lithia's US units sold in the quarter. Loan-loss provision as a percentage of average managed receivables fell 10 basis points to 1.1%. Service was the only segment to grow same-store sales year over year. We believe the importance of this segment, with gross margins over 50%, is overlooked by investors who incorrectly assume that dealers cannot make money unless new-vehicle sales are healthy.

The bottom line: We are raising our fair value estimate for narrow-moat Lithia to $430 per share from $426 on the time value of money. We think the firm's prospects for continued organic and roll-up acquisition growth in the US and UK remain excellent. Lithia bought back 3.7% of its stock in the quarter for $242 million, or only $284 per share. We like that this occurred well below our fair value estimate and far below where the stock trades on July 29 at over $420. Investors should expect more buybacks in the second half of the year. We think Lithia has leveraged technology and its size to create a strong flywheel across the firm, leveraging the synergies of service and financing that selling new and used vehicles brings. The large buybacks and significant dividend increase show management's confidence in the future.

We are raising our fair value estimate to $430 per share from $426 on the time value of money. Following the close of the Pendragon deal in the UK, which is a region that has less lucrative financing operations than US dealers, management in a 2024 slide deck lowered its then so-called “future state” 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 our midcycle operating margin at 4% on better overhead cost scaling as revenue keeps growing over time. We find Lithia’s long-term growth story very attractive, and we could see our fair value estimate rising over time.

We model Lithia reaching its long-talked-about (but now deemphasized) milestone of $50 billion in revenue in 2030. Midcycle operating margin increases are possible to capture possible additional scale benefits as Lithia keeps expanding and because it is an excellent operator in leveraging its overhead. Long term, and probably beyond 2030, management targets $2 in EPS for every $1 billion in sales. Total revenue over our five-year forecast period is around $225 billion. Our five-year revenue compound annual growth rate is about 7%. Operating margin including floorplan interest for our entire stage one five-year forecast averages about 4%. We model $2 billion of annual acquired revenue in 2026 at a price/sales multiple of 0.25. We model about $4 billion for each year of 2027-30, all at a price/sales multiple of 0.25. Management is a strong operating team, so we give it a lot of benefit of the doubt that the Driveway online shopping portal can keep growing and bring unprecedented expense leverage due to more digital capability.

Our weighted average cost of capital assumption is 8.3%. Lithia tends to have one of the lowest ratios of selling, general, and administrative expense as a percentage of gross profit in the dealer sector; thus, it is a top operator, which can result in positive earnings surprises.

Despite good SG&A efficiency, the company has room to improve its SG&A expense as a percentage of gross profit, as SG&A efficiency is not uniform across the company and large deals could bring more scale from more profitable types of used sales, more leasing business, and more lucrative financing business. Lithia also has many recently acquired stores that are not yet up to management's expectations. In 2022, the company talked about how its larger stores acquired have better SG&A leverage than smaller stores acquired, which is influencing the type of stores it wants to acquire. Lithia still has a very long growth runway ahead and is investing in new verticals such as RV dealerships, electric vehicle charging, and fleet management. By the end of 2028, the company will have moved its dealer management system to Pinewood, which should help improve SG&A leverage.

The Driveway Finance Corp. captive finance arm had an average loan book at the end of the second quarter of 2026 of $5.3 billion. The company sees the loan book reaching $17 billion long-term, ultimately financing 20% of Lithia's US retail unit sales (up from 14.5% in 2025). A DFC loan has about triple the profits over the loan's life compared with a third-party commission that Lithia gets for getting a customer financed from a Lithia lending partner. Management guides for DFC to eventually generate $550 million-$600 million in earnings on a $17 billion loan portfolio, up from $74.6 million in 2025. We think Lithia will keep realizing strong SG&A leverage as it brings newly acquired stores up to its operating standards and gets the scale to match its growing size. We model capital expenditures to just below 1% of sales per year on average.

We assign Lithia a Narrow Morningstar Economic Moat Rating. The firm not only enjoys the same narrow-moat traits as the other public dealers (cost advantage and intangibles), but also has the distinctive rural market focus that gives it no formidable competition for a given brand. State franchise laws are another source of the sector's moat, and Lithia's rural focus makes this advantage even more powerful than its competitors by giving the company efficient scale. Franchises are difficult to terminate even in an OEM bankruptcy, and laws exist stating that a brand cannot have a rival store within a fixed distance of an existing one. This distance plays right into Lithia's business model: If one goes just outside towns such as Fairbanks, Alaska; Midland, Texas; or Billings, Montana, there is little to no development. It also owns dealerships in Hawaii because an island limits the number of stores a brand will have there.

Despite the DCH deal in 2014 and subsequent purchases moving the company into large metropolitan markets, management is retaining its rural strategy. Lithia now pursues growth in both rural and metro areas, so we see no reason to change our moat rating because of the strategy change to both metro and rural markets. Lithia's competitors operate in large metro areas and also have narrow moats, just not from efficient scale, as Lithia does with its rural market niche. Other dealers' moats come from cost and intangible advantages, which Lithia also shares.

We think the dealer sector is the best business in the automotive supply chain. The public dealers can centralize back-office operations and generate far more volume than a small dealer, which brings scale. Dealers have no burdensome retiree expenses, and the large public dealers are not dependent on the health of one brand. The dealers enjoy mid- to high-single-digit gross margins on new vehicles and 100% gross margins on financing and insurance. We think the best source of competitive advantage is the parts and service operations. Many customers bring their vehicle to the dealer for servicing because the vehicle is either under warranty or because the dealer is close to home and has the factory parts and expertise to service the vehicle. Once vehicle owners know a dealer, we think they are likely to keep going back to the dealer for service. The dealer knows the vehicle, and comparison shopping for repair work is very time-consuming, as the customer has to bring the vehicle to each shop to get a quote.

These logistics create inelasticity of demand, which in turn creates pricing power for the dealer and is a source of excellent profit in good times and bad. In fact, during a downturn in new-vehicle sales, dealers generally report higher gross margins, owing to a favorable mix shift, but then report lower operating margins because of selling, general, and administrative expense deleveraging. 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 since these firms can be the most flexible in changing brand mix, and their growing size means they can achieve working-capital efficiencies by moving inventory around their store base. 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. About 91% of dealer owners own between one and five stores per the National Automobile Dealers Association and we see that ratio continuing to fall over time, so we see a long growth runway for consolidators such as Lithia.

Lithia’s growth runway looks very long to us; acquisitions are opening up new areas of the US, and international expansion has started by entering Canada in 2021 and the UK in 2023.

Manufacturers grant a limited number of franchise rights in a given geography, providing dealers with some protection against would-be competitors.

Lithia's rural niche in the US, in our opinion, makes it the Walmart of auto dealers.

Lithia could need additional capital to fund expansion. In addition, it will face increased competition for acquisitions now that it will operate in large cities.

Making many large acquisitions close together brings integration risk.

If gas prices ever get severely high, Lithia could suffer because its rural customers favor pickups and SUVs.