Even after announcing a large buyback and hefty 20% dividend increase in March, shares of the leading U.S. automaker, General Motors (NYSE: GM), have continued to slide lower. They are down close to 20% over the last three months. Shares of Ford (NYSE: F) haven’t fared much better.
This trend in auto industry stocks is especially puzzling, maybe even concerning, when you consider the fact that the U.S. is seeing its best auto sales in close to a decade.
Fiat Chrysler Automobiles (NYSE: FCAU) has made advances toward GM, pushing for a merger of the two. Any time competition heats up, consolidation is one way to band together and protect pricing. Yet GM has rebuffed Fiat twice in the last four years, believing that it’s best served on its own.
The major U.S.-based automobile players may have other issues too, including the fact that one of their key “growth” markets, China, may be seeing an economic slowdown.
There are still overcapacity concerns here in the U.S. for autos and plenty of uncertainty ahead for the automakers. Until that plays out, it will be tough to own the major automaker stocks.
And add to that the millennial generational shift. We’re already seeing the impact of a shift away from homeownership toward home rentals. Along those lines, could the sharing economy spill over into the auto market? Perhaps, but it’s hard to see the multi-billion car industry going away anytime soon.
There is one part of the market that might still be worth owning and that’s the car dealerships. These guys have exposure to car sales, both new and used, but also the less cyclical repair auto market.
This is also a part of the auto industry that’s not shy about consolidation. It seems to be on the right track. Heck, if Warren Buffett and Berkshire Hathaway (NYSE: BRK-B) believe in an industry, it’s certainly worth a look.
Buffett’s Auto Bet
Buffett’s Berkshire Hathaway bought the auto dealership giant Van Tuyl Group, rebranded as Berkshire Hathaway Automotive, last year. It plans to expand its already large presence across the U.S.
The beauty of the dealership business is that the industry remains very fragmented, leaving plenty of opportunities for buyouts.
Back in May, I noted that Buffett was doubling down on car dealerships. The thesis hasn’t changed, with auto dealers remaining an enticing industry. If anything, more enticing now that automakers are on the ropes.
A Bullish Call
AutoNation (NYSE: AN) was the pick du jour at the time and is up 7.5% since. However, the bullish call is still intact. Parts, services and repairs are a high margin business for auto dealerships. It’s a business AutoNation is looking to get more involved in, despite the fact that close to half its gross profits are already generated from this segment.
The beauty of the repair market for car dealers is that they have an advantage over smaller repair shops, where automakers generally require any warranty work to be done at a dealer.
AutoNation still has one of the best balance sheets in the dealership space and is one of the cheapest, with a forward price-earnings ratio of 14.5 based on next year’s earnings estimates.
But if you really want to talk cheapness, in terms of valuation Penske Automotive Group (NYSE: PAG) is your go-to. It trades at a forward P/E ratio below 11.5. One of the big advantages for Penske is that it caters to the high-end market. Close to 100% of its dealer revenues are from luxury and premium brands.
That’s not to say that Penske also doesn’t enjoy exposure to the high-margin repair market. About 40% of its gross profits are from that business. Being a bit smaller than AutoNation, Penske can also look to buy some of the smaller dealers where the added revenues would be enough to justify the purchase.
While buying Berkshire Hathaway will get you exposure to the auto dealers, it’s not the pure-play you need. AutoNation remains the all-around best play. Penske is also enticing given its cheapness and exposure to the high-end market.
Tesla, Apple and Google are creating this
When people think of Tesla, what immediately comes to mind is the world’s first electric car. It’s an astounding achievement. But what few people realize is that Tesla’s next technological wonder could easily put it to shame. Morgan Stanley says this breakthrough could save the American economy $1.3 trillion each year. And Tesla’s not the only one racing to get it out the door. Apple and Google are working on their own versions too. Get the whole story right here.