Carvana and Lithia Motors Drive New Trends in Car Buying

08/05/2019 5:00 am EST

Focus: TRANSPORTATION

Michael Cintolo

Vice President of Investments and Chief Analyst, Cabot Heritage Corporation

We’re fascinated by the publicly traded car dealerships since we, along with most everyone else in the world, hates walking into a dealership to buy or lease a new car, explains Mike Cintolo, editor of Cabot Top Ten Trader.

But by analyzing these companies you can see where car dealerships make the most money — in financing (including extended warranties) and used cars.

Beyond that, we like Lithia Motors (LAD) because the stock is doing well and the fundamentals are solid. The company operates over 180 dealerships in 18 states across the country, through which it sells almost 30 brands of new and used cars and light trucks.

New vehicles make up just over half of sales, used cars about a quarter, and service, wholesale cars, insurance, etc., make up the balance. Lithia has differentiated itself from the competition by excelling in those higher margin used-car sales, which also feed into its parts and service business.

The bottom line is that revenue and EPS have been growing in the double digits, in part because of acquisitions, and the stock just broke out after a better-than-expected Q2 report last week.

Revenue was up 4.2% to $3.2 billion, while EPS of $2.95 beat by $0.13. Analysts liked the quarter, and with a strong balance sheet see Lithia snapping up more dealerships to keep the growth trend alive.

Lithia Motors peaked near $120 last March and was cut in half by December, but the stock’s advance this year has been both smooth and powerful. The shares recently surged on earnings, so if you want in, aim for dips.

Meanwhile, Carvana (CVNA) is revolutionizing the gigantic used car business ($760 billion) in the U.S. by selling online, providing not just better prices ($1,000 average savings per vehicle), but a ton of selection (more than 18,000 choices, gotten from auctions, off-lease and off-rental, etc.).

It also has a user-friendly, photo- and video-rich website and app (360 degree views of the car; purchases can be completed in as little as 10 minutes), ancillary services (buying trade-ins, providing financing) and offering important guarantees (no car it sells has ever been in a reported accident; most have a seven-day “test drive” period after purchase).

From an investment point of view, the main attractions here are the rapid revenue growth and still-huge expansion potential (selling in 85 markets at year-end 2018, rising to 140-plus by end of 2019, bolstered by a huge and growing logistics network) but also the very encouraging sub-metrics.

While earnings remain deep in the red, gross margin per car sold is rising nicely (expected to rise 20% this year to $2,550), and most new markets are producing steady market share gains (its oldest markets have achieved near 2% share). Analysts see revenues up 85% this year and another 53% next, both of which are likely low. Earnings are due August 7.

Technically, Carvana has rested for the past 10 weeks, but that is really part of a 10-month consolidation — shares topped out last September, fell by 60% during the market’s implosion, but then rallied all the way back to new highs by late April.

Super-deep corrections usually lead to a shallower consolidation, and that’s what we’ve seen since the start of May. If you’re game, you could nibble here with a loose stop and see if a breakout comes before or after earnings.

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