Auto sales are picking up, which is great news for dealerships.
But it’s not just the short-term boost that auto dealerships are seeing that makes them a solid investment. The truth remains that cars have been around for nearly a century and dealerships continue to be the main way consumers buy and sell vehicles. This is a trend could easily continue for another century.
Even Warren Buffett loves this business. His Berkshire Hathaway (NYSE: BRK-B) bought over 80 dealerships from Van Tuyl Group earlier this year. It was the largest privately held car dealership group at the time.
Buffett believes auto dealerships are a business that will still be thriving 100 years from now. He even purchased a Honda dealership last month and said he plans on growing his dealership business with additional purchases.
But Buffett isn’t the only billionaire enamored with selling cars. Hedge fund magnate George Soros has been eyeing dealerships as a possible investment. He’s either looking to take a minority stake in a large group of dealerships or pull a Buffett and just buy one.
Let’s not forget that Buffett’s buddy, Microsoft (NASDAQ: MSFT) co-founder Bill Gates, is also a big believer in the dealership business. Gates, via his foundation and private investment firm, owns a 15% stake in AutoNation (NYSE: AN).
There are a number of advantages to auto dealerships, including the fact that they operate as a cartel of sorts, with protection from state laws that help limit competition. Hence the reason that Tesla Motors (NASDAQ: TSLA), which doesn’t use a dealership sales model, has been facing so many headwinds by state regulators.
After Buffett’s foray into the space, many major dealership operators have seen their stocks pushed higher. Is it too late for retail investors?
Some of the public players in the space include the likes of AutoNation, CarMax (NYSE: KMX), Lithia Motors (NYSE: LAD) and Group 1 Automotive (NYSE: GPI).
While all of the major players here may not be a good value, there are still ways to invest like Buffett, so to speak.
CarMax is the biggest player, but it’s trading north of 20 times forward earnings (based on next year’s earnings estimates). However, Group 1 is trading at 11.4 times forward earnings and AutoNation at 14 times.
Group 1 offers one of the few dividends in the auto dealership industry, coming in at a 0.9% yield. AutoNation has the best return on invested capital among major dealership businesses, currently over 10%.
AutoNation is enjoying superior returns thanks to its sheer size. Its operating costs – namely, selling and administrative expenses (as a percent of revenue) – are much lower than the industry average.
What’s more is that all the new cars being sold over the last couple years will provide a continuous flow of repair work. It’s worth noting that parts and services are the most lucrative part of a dealership. While AutoNation only generates 15% of its revenues from parts and services, that business generates over 40% of its gross profit. And it’s no surprise that AutoNation has been looking to expand more into auto repair operations.
AutoNation has one of the best balance sheets in the industry, yet it’s been lagging major peers in terms of stock price performance. I think that will change going forward.
Despite the excitement over Buffett’s entry into the auto dealership space, it’s not too late for investors to capitalize on the Oracle of Omaha’s vision. AutoNation looks to be that play.
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