As of April 19th, 2017, AutoNation is trading for $43 and has a market cap of $4.37 billion. The company trades under the ticker symbol “AN” in the NYSE. This is not utterly important! Forget this! Leave it for the end, how does AN generate cash?
Warren Buffett tells us to judge the performance of a company by looking at their 4-5 year history, at the minimum, preferably 10 years, if available. Look for the intrinsic value of the company and pay a fair or bargain price. Let’s go step-by-step:
As previously mentioned, you cannot analyze the value of a company without looking at ten years or more of its financial history.
Let’s take a look at AutoNation from 2006-2016 and see how the company has behaved. This is a good frame period since it covers the pre and post of the great recession of 2009.
AutoNation is the largest automotive retailer in the United States and sells 35 different new vehicle brands such as BMW, Audi, Toyota, Mercedes-Benz and many more.
Looking at the history of the Free Cash Flow and Shareholder Equity (net worth) of AN, we find that Free Cash Flow has averaged $200 million during the past 10 years; however, Shareholder Equity has actually decreased by more than $1 billion, compared to 2006-07.
When buying a business or a piece of it (stock/ share), you are investing in the net worth of the company and future cash the company can generate. From a quick glance, the numbers point to a promising growing company, but when you look deeper in their financials, their numbers start to reveal weaknesses in the business structure.
A First Glance Into AN
- The revenue of the company has grown by almost $5 billion. They are selling vehicle units at higher levels, pushing their sales to new highs.
- The earnings per share, acronym EPS (the number Wall Street lives and dies for) has gone from $1.41 per share in 2006 to $4.18 per share in 2016.
- Shares Outstanding in 2006 reached 225 million. Their share repurchase program pushed down the total shares to 103 million in a matter of 10 years.
- The revenue from sales of new cars has doubled in less than 10 years.
The Down Side
- Sales of new vehicle units reached slightly higher levels than in 2006 before the decline toward the great recession. There is no growth in new unit sales compared to 2015.
- The margins keep shrinking year-after-year. The sale of a new car left a net profit margin of 7.1% and of a used car at 10.7% in 2007. Today, respectively, the numbers are 5.6% and 8.2% for 2015.
- The increase in EPS (mentioned above) is highly attributed to the share repurchase program that has taken place in the last 10 years. The company itself has bought shares as high as $60 per share. This is at 40% premium from today.
- Days in inventory and cash conversion have reached a new high.
You’re Tapping AN’s Net Worth
In 2016, AN had $2.3 billion in net worth. This means that if you would own AutoNation and they went out of business tomorrow, you would be entitled to your fair share of $2.3 billion (this is assuming all of their assets sell at a fair value). We do not expect AN to go out of business tomorrow and, even less, to liquidate their assets. This is hardly the case, but it is a good starting point of reference for this business.
We want them to be in business for many more years; hence, we need to figure out how much cash they can produce for the next twenty years.
AutoNation Free Cash Flow changed frequently, running up 40% one year, dropping 9% another. We need to find a realistic average as to what their cash flow will look like in the future.
How Much Cash Can They Generate
The average Free Cash Flow for this business grows on average slightly over 2% in multiple timeframes and an average of $200-250 million of cash flow.
We can expect AN to grow its Free Cash Flow 2% in the future for at least ten years. If we’re wrong and AutoNation grows more than 2% or is able to free up cash from operations higher than $250 million in the future, we end up making a lot more money.
This is where it gets tricky. We have to be able to forecast gains and discount them back to today (Present Value of Money). In order for you to make money, you need to pay less today for that dollar in the future. It is important to understand the company and their earning power. How their numbers could be compromised and a margin for error should always be considered in your calculations. It is foolish to think you will not make a mistake or miscalculate something.
Gluing It Together
Our calculations tell us that AutoNation can expect over $3 billion in cash earnings for the next 10 years or a total valuation of over $4 billion today, being conservative. Today’s trading price of $43 per share and market conditions gives us a fair value of approximate current stock price. Remember, you have to leave room for error. We like to use 25%, so this means if we are wrong in our calculation, we would feel better if we can buy AutoNation for $33 a share.
Regarding management, the company has about $1.6 billion in debt. In the past 10 years, they have used over $5 billion buying shares back regardless of share price. Based on numerical calculations, when share prices were in the high $50s and $60s, the management should have employed the cash to liquidate debt rather than purchase shares. Management could have done a better job about their debt levels.
Disclosure: I/ we have not position in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.
I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.
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