Sonic Automotive: Consider Near-Term Outlook And Financial Strength

Elevator Pitch

My investment rating for Sonic Automotive, Inc.'s (NYSE:SAH) stock remains as a Hold. I previously wrote about SAH's prospects for this year and the disruption risk for automotive dealers in my earlier January 2, 2023 article.

In the current write-up, my attention turns to Sonic Automotive's near-term outlook and its financial strength. On one hand, I think that SAH will deliver lackluster results for Q2 2023 as per the market's expectations. On the other hand, I think that Sonic Automotive has levers to enhance shareholder value in the long term thanks to its financial strength. Taking into account these above-mentioned factors, I decided that a Hold rating for Sonic Automotive is appropriate.

Q2 2023 Is Expected To Be A Tough Quarter For Sonic Automotive

SAH is expected to announce the company's financial results for the second quarter of 2023 in late-July, and the market sees Sonic Automotive reporting a decline in revenue and a drop in earnings for Q2 2023.

In the past three months, five of the eight Wall Street analysts covering Sonic Automotive's shares have cut their respective Q2 2023 normalized earnings per share or EPS forecasts for the company. In fact, the sell-side's consensus second quarter non-GAAP adjusted EPS estimate for SAH was lowered by -20% during this same period. Specifically, the market is currently predicting that Sonic Automotive's top line and bottom line will decrease by -2% and -35% to $3.6 billion and $1.59 per share, respectively in YoY terms.

In my view, there are good reasons for the sell-side's pessimism regarding Sonic Automotive's outlook for the near term.

One key factor is that SAH's Q1 2023 below-expectations financial performance, which can't be fully attributable to seasonality, offers negative read-throughs for the company's Q2 results.

The company's normalized EPS fell by -43% YoY to $1.33, which was -28% below the consensus bottom line projection of $1.83 per share. At the company's Q1 2023 earnings call in late-April, Sonic Automotive highlighted that "we always seem to be a little light weighted in terms of what happens with what the Street comes out with in the first quarter." But SAH's Q1 2022 EPS was only -1.5% below expectations, while the company's Q1 2021 and Q1 2020 bottom line even exceeded the market's consensus estimates by +34% and +82%, respectively.

Another key issue to note is that unfavorable macroeconomic factors will still be a drag on Sonic Automotive's top line and bottom line in the second quarter.

SAH acknowledged at its first quarter earnings briefing that "macroeconomic uncertainty" and "rising interest rates" might "drive volatility in consumer demand and vehicle margins" in 1H 2023. Separately, two in three US consumers still think that this is a "bad time to buy" new cars as per the results of the most recent April 2023 University of Michigan consumer survey.

In summary, Sonic Automotive's Q1 2023 earnings miss and the weak economic environment suggest that there is a high probability of SAH performing poorly in the second quarter as per analysts' expectations.

Financial Strength Will Allow SAH To Survive And Thrive In Challenging Times

Sonic Automotive should be able to stay afloat and do well in difficult times, thanks to its strong financial position.

As indicated in its April 2023 investor presentation, SAH's net debt-to-EBITDA ratio is reasonably comfortable at just 1.89 times as of end-Q1 2023. Moreover, Sonic Automotive boasted liquidity of close to $900 million, comprising of cash and other credit facilities, as of March 31, 2023.

In a worst case scenario where the economy goes into a severe recession and there is a prolonged bear market, SAH has the financial strength to survive considering its low financial leverage and ample liquidity. At the company's Q1 2023 results call, Sonic Automotive stressed that its top priority is "ensuring we have enough dry powder for any kind of economic conditions that may be coming down the road."

More importantly, Sonic Automotive's strong financial position means that it has the ability to pull on multiple value creation levers.

A key value creation lever is mergers & acquisitions or M&A. Earlier in February 2023, SAH disclosed the "acquisition of Black Hills Harley-Davidson, the world-wide preeminent Harley-Davidson dealership located in Rapid City, South Dakota." It is reasonable to assume that Sonic Automotive will do more of such M&A deals to expand its presence in the powersports market. In the company's April 2023 investor presentation, SAH referred to the North American powersports industry as a large and fragmented market which throws up acquisition opportunities for the company. Specifically, the size of the powersports market in North America is as large as $34 billion, where 85% of the players only operate from one location as per Sonic Automotive's research.

The other key value creation lever is shareholder capital return. Capital-constrained companies will likely cut dividends and suspend share repurchases in challenging times to conserve capital. But Sonic Automotive's capital strength enables it do the opposite. SAH recently raised the company's quarterly dividend per share by +3.6% from $0.28 to $0.29. Separately, Sonic Automotive spent $90.7 million on share buybacks in Q1 2023 and its still has $373.6 million available for future share repurchases as per its current authorization to capitalize on weakness in its stock price.

Closing Thoughts

I have a mixed view of Sonic Automotive. On the positive side of things, I have a favorable opinion of SAH's financial strength which gives the company the chance to drive value creation via optimal capital allocation. On the negative side of things, Q2 2023 is most probably going to be another disappointing quarter for Sonic Automotive, just like how SAH performed in the first quarter. As such, I stick to a Hold rating for SAH.

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