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Elevator Pitch
I continue to assign a Hold rating on Sonic Automotive, Inc.’s (NYSE:SAH) shares.
My prior write-up for Sonic Automotive dated August 2, 2022 focused on the outcome of EchoPark’s (pre-owned vehicle business) strategic review and SAH’s Q2 2022 financial results.
This latest update touches on the future of automotive dealers, Sonic Automotive’s capital allocation priorities and 2023 business outlook. My analysis suggests that a Hold rating for SAH is justified.
Sonic Automotive is expected to turn in a weaker financial performance for 2023 (vis-a-vis 2022), and this explains why SAH’s current valuations are much lower than historical averages. But further downside for Sonic Automotive’s shares is limited by the fact that the company has the capacity and intention to conduct meaningful share buybacks.
The Future Of Automotive Dealers
Prior to discussing specifically about Sonic Automotive, it is worth spending some time considering the future of automotive dealers.
There are many investors who fear that traditional automotive dealers might no longer be relevant as electric vehicle or EV penetration grows. Electric vehicle makers typically bypass dealers and sell their products to consumers directly. But such fears might be overblown as evidenced by Ford Motor Company’s (F) recent moves.
Recent news flow relating to F suggests that legacy automakers aren’t doing away with dealers even as they try to ramp up EV sales. In September 2022, a CNBC news article quoted Ford’s CEO emphasizing in an interview that the company is “betting on the dealers” and it is “not going to go direct.” Also, almost two-thirds of F’s existing dealers have already decided to participate in Ford’s EV investment program, according to an early-December CNBC piece.
In the case of Sonic Automotive, the company has already achieved 100% coverage of EV infrastructure for its dealerships by the end of 2021. In other words, the disruption threat posed by the rise of EVs might not be as severe as earlier feared.
Share Repurchases
Sonic Automotive has made the right capital allocation decision by aggressively buying back its own shares last year.
In the first 10 months of 2022, SAH spent around $245 million repurchasing 5.2 million of its own shares as disclosed in its investor presentation slides. This meant that Sonic Automotive’s shares outstanding decreased by -13% from 40.7 million as of December 31, 2021 to 35.5 million as of end-October 2022.
It is noteworthy that Sonic Automotive’s valuations were pretty depressed in the past one year. Based on data taken from S&P Capital IQ, Sonic Automotive traded between 4.7 times and 7.0 times consensus forward next twelve months’ EV/EBITDA in the last year. During this same period, the market valued SAH in the consensus forward next twelve months’ normalized P/E multiple range of 3.5-6.3 times. In comparison, Sonic Automotive’s 15-year mean forward EV/EBITDA and normalized P/E valuation multiples were relatively higher at 9.6 times and 9.7 times, respectively.
Therefore, it is reasonable to conclude that SAH’s valuations were undemanding in 2022, and the company did the right thing by engaging in substantial share repurchases in this time frame.
More significantly, it is very likely that Sonic Automotive will continue to buy back more of its shares, as long as its stock’s valuations stay attractive. SAH had commented at its most recent third quarter earnings briefing in end-October 2022 that the company will consider share buybacks “when it’s (the company’s shares) undervalued” and emphasized that “we still believe it’s undervalued.”
Notably, SAH has $481 million remaining from the company’s share buyback authorization as of October 31, 2022, and this is equivalent to a significant 27% of the stock’s current market capitalization. In a nutshell, Sonic Automotive’s commitment to share buybacks will create value for shareholders (as they are value-accretive), and also provide support for SAH’s stock price to some extent.
Challenging 2023 Outlook
This will be a tough year for Sonic Automotive. This won’t be a big surprise, as automotive dealers are cyclical businesses whose prospects are heavily dependent on the health of the economy.
SAH is expected to register slower top line expansion and negative earnings growth in 2023. According to the market’s consensus financial figures sourced from S&P Capital IQ, Sonic Automotive’s revenue growth is projected to moderate significantly from +14.8% in fiscal 2022 to a mere +1.2% for FY 2023. Also, analysts forecast that SAH’s normalized earnings per share or EPS will decline by -13.3% for FY 2023 as compared to an estimated +9.6% bottom line growth in fiscal 2022.
The sell-side’s consensus numbers for Sonic Automotive are reasonable and realistic, if one considers the outlook for SAH’s various business segments. As mentioned in its investor presentation, Sonic Automotive earned 34%, 37% and 29% of its 9M 2022 gross profit from the Parts, Service & Collision Repair, New Vehicle & Used Vehicle, and Finance & Insurance business segments, respectively.
It is inevitable that SAH’s New Vehicle & Used Vehicle business line will perform poorly in the current year, as difficult economic conditions and weak consumer sentiment are expected to hurt vehicle sales. The performance of the company’s Finance & Insurance business could also be negatively affected by the downward pressure on vehicle selling prices. On the other hand, Sonic Automotive’s Parts, Service & Collision Repair business line should be the most resilient, as drivers opt to spend money maintaining their existing vehicles rather than buying new ones.
Concluding Thoughts
A Hold rating for Sonic Automotive is fair. SAH’s 2023 business outlook isn’t encouraging, but this is already reflected in the stock’s depressed valuation multiples.
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