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I have a Hold investment rating for Sonic Automotive, Inc.’s (NYSE:SAH) stock. I reviewed SAH’s financial results for the third quarter of last year in an earlier update for the company written on November 5, 2021. I analyze Sonic Automotive’s most recent Q2 2022 performance, and the company’s decision to complete the strategic review for its pre-owned vehicle business, EchoPark in this article.
I have a negative view of Sonic Automotive’s below-expectations Q2 2022 financial results and its conclusion of EchoPark’s strategic review. However, I am positive about the potential turnaround for EchoPark in the second half of this year with expectations of narrower losses on a HoH (Half-on-Half basis). I remain Neutral on SAH with a Hold rating, and I will prefer to wait for greater clarity with regards to EchoPark’s new long-term growth targets (to be provided by management at a later date in future) before turning Bullish on the name.
Sonic Automotive’s Record-Breaking Results Were Still Below Expectations
Certain of SAH’s key quarterly financial metrics reached historical highs in the second quarter of 2022 as per the company’s Q2 earnings press release, but the company’s headline financial numbers didn’t meet investors’ expectations.
Sonic Automotive’s top line expanded by +9% YoY from $3,352 million in Q2 2021 to $3,653 million in Q2 2022, while its gross profit grew by +15% YoY from $511 million to $589 million over the same period. It is worthy of note that SAH’s second-quarter revenue and gross profit were the highest that they have ever been in the company’s history.
But SAH delivered revenue and earnings misses for the recent quarter. Sonic Automotive’s actual Q2 2022 revenue came in -6% lower as compared to the market’s consensus sales estimate of $3.9 billion. More significantly, SAH’s non-GAAP adjusted EPS contracted by -7% YoY from $2.63 in Q2 2021 to $2.45 in Q2 2022, and this turned out to be -4% below the sell-side analysts’ consensus bottom line estimate of $2.55 per share.
The company’s top line missed market expectations in Q2 2022, largely because its same store sales for the Franchised Dealerships segment decreased by -12% YoY in the recent quarter. At its Q2 2022 results briefing on July 28, 2022, Sonic Automotive explained that was the result of “a 20% decrease in industry new vehicle volume as a result of ongoing vehicle production constraints.”
Sonic Automotive’s overall bottom line fell short of the sell-side analysts’ expectations, as the company’s loss before tax for the EchoPark business segment widened from -$14 million in Q2 2021 to -$35 million in Q2 2022. The sales volume for EchoPark fell by -22% YoY to 16,608 units in the most recent quarter, and SAH noted at its second-quarter investor call that it has “taken steps to adjust our headcount and expense structure at EchoPark to better align with current volume levels.” This implies that negative operating leverage had hurt EchoPark’s profitability in Q2 2022.
In the next section, I discuss about the company’s management updates with respect to the strategic review for EchoPark.
Update On EchoPark’s Strategic Review
In my previous August 20, 2021 update for Sonic Automotive, I mentioned that SAH “proposed a strategic review of the EchoPark pre-owned vehicle business”, and I emphasized that “a potential spin-off might lead to a re-rating of the company’s shares in the future.”
But Sonic Automotive disclosed in the company’s recent Q2 2022 results media release that it “has concluded its review” for EchoPark, and highlighted that “the Board has determined that timing and current market conditions do not align with the Company’s value creation objectives for the business.”
In other words, there is a very low chance of any corporate transactions with the aim of unlocking the value of its pre-owned vehicle business, EchoPark, materializing in the near term. Like any other company which owns two or more disparate businesses with different characteristics, SAH suffers from a valuation discount that can only be narrowed with a separation of these businesses. As such, it is disappointing that Sonic Automotive’s strategic review for EchoPark has been completed without any concrete actions or plans announced.
I go into detail about EchoPark’s potential turnaround in the subsequent section.
Turnaround For EchoPark Will Be Key Re-rating Catalyst
As I noted in an earlier section of this article, wider-than-expected losses for EchoPark have led to an earnings miss for Sonic Automotive in Q2 2022. Looking forward, a turnaround of the EchoPark business will hold the key to a positive re-rating of SAH’s share price and valuations in time to come.
Unfortunately, the outlook for EchoPark is mixed.
On one hand, Sonic Automotive revealed in its Q2 2022 earnings media release that the company has decided to “push back the achievement of its previously stated financial goals beyond 2025” in view of “the current market environment.” In my August 20, 2021 article for SAH, I had made reference to Sonic Automotive’s earlier stated $14 billion fiscal 2025 top line goal for EchoPark. SAH stressed at its second-quarter earnings briefing that it is the issue of supply rather than demand which has caused it to defer its FY 2025 revenue target. Specifically, Sonic Automotive emphasized that “we couldn’t buy 1- to 4-year-old vehicles” because “they’re just very hard to get.” Notably, SAH will only issue new long-term guidance for EchoPark again in the future when market conditions stabilize.
On the other hand, SAH has guided at its recent quarterly earnings call that it expects losses for EchoPark to be narrower in the second half of 2022 as compared to the first half of this year. Sonic Automotive’s confidence in EchoPark achieving an improvement in profitability for 2H 2022 stems from two key points. Firstly, EchoPark has increased its proportion of inventories from bought from sources other than auctions (where prices are in general more expensive) to 57% last month. Secondly, SAH has observed a trend of declining auction prices on a month-on-month basis in July 2022.
Closing Thoughts
SAH is a Hold. Sonic Automotive’s Q2 2022 bottom line miss and the completion of the strategic review for EchoPark without any specific actions have been disappointing. On the flip side, there are positive expectations that EchoPark’s losses will be lower HoH in the second half of the current year, even though SAH has pushed its 2025 top line target backwards. This translates into a Neutral view and a Hold rating for Sonic Automotive.
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