AutoNation's record Q3 earnings: Balancing inventory woes, growth

With new-vehicle inventory dwindling on AutoNation Inc.'s dealership lots amid the microchip shortage, the auto retail giant is reaping higher profits on the new cars it does have and is turning even more heavily to used vehicles.

Those strategies were readily apparent as AutoNation reported record third-quarter results last week that included all-time-high new-vehicle gross profit per unit.

At the same time, the country's largest new-vehicle retailer — in its final weeks with longtime CEO Mike Jackson at the helm — is looking at how to invest for the future. AutoNation last week announced a deal to buy nine dealerships and revealed details of a share buyback spree.

On the chip front, AutoNation's new- vehicle inventory dropped to just a 10-day supply at the end of September, worse than the 14-day supply it had at the end of June and far below the 43-day supply of September a year earlier. The company had just 8,041 new vehicles on hand as of Sept. 30, compared with 40,615 at the same point in 2020, according to a regulatory filing.

Jackson, who retires Nov. 1 after more than two decades leading the company, told analysts last week that the inventory number is now at 5,000 to 6,000 vehicles.

"Hopefully this is the bottom of where production is and that we see gradual improvement," said Jackson, who will hand off leadership to former Fiat Chrysler Automobiles CEO Mike Manley next week.

AutoNation's new-vehicle sales volume dropped 12 percent in the quarter, while new-vehicle revenue remained flat. But with a heightened focus on used vehicles, sales volume for those cars jumped 20 percent, and used-vehicle revenue surged 53 percent.

Shoppers are willing to buy a new vehicle close enough to what they want in today's tight inventory market or select something in the pipeline and wait for it, Jackson said. Others will switch to used vehicles or say they will wait until next year. Jackson views that as building "pent-up demand."

Stephens Inc. analyst Rick Nelson said in a note to investors last week that inventory levels likely won't improve immediately when vehicle production increases. The reasons are overall high consumer demand and that much of the incremental production will go to buyers who already have ordered vehicles.

"We don't believe that inventory will materially improve until well into 2022," Nelson wrote. "As a result we see outsized new vehicle margins over the coming quarters."

How AutoNation's inventory situation plays out in the fourth quarter and next year will be on Manley's watch.

Manley also will lead AutoNation's capital allocation strategy, which has included expanding the retailer's platform of AutoNation USA used vehicle-only stores, buying back shares and returning to dealership acquisitions.

Last week, AutoNation said it had signed an agreement to buy Priority 1 Automotive Group of Towson, Md., pending automaker and other approvals. The acquisition, which covers nine luxury dealerships and three collision centers, is expected to generate about $420 million in annual revenue. A closing date is slated for November.

In late September, AutoNation purchased 11 dealerships and a collision center from Peacock Automotive Group in a deal originally announced in April. Those stores are expected to generate $380 million in annual revenue.

The deals were the first acquisitions for AutoNation after being on the sidelines of the buy-sell market since 2018.

"We will continue to look for additional acquisitions that complement our portfolio and meet our return thresholds," AutoNation CFO Joe Lower told analysts last week.

From Sept. 30, 2020, to Sept. 30, 2021, AutoNation spent $2.2 billion to buy back 27 percent of its outstanding shares of stock. During the third quarter alone, AutoNation spent $879 million to repurchase nearly 11 percent of its own shares.

The company's board of directors has authorized spending an additional $1.3 billion on stock repurchases.

Jackson has largely favored stock buybacks over paying what he has described as high prices to acquire dealerships.

And some analysts see that strategy continuing.

Truist Securities analyst Stephanie Moore, in a note to investors last week, said that with AutoNation's $1.8 billion in liquidity, "we expect share repurchases to serve as a main part of its capital allocation strategy."