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LAD AT A GLANCE

P/E ► 13.1 LOW EV/EBITDA ► 6.16 LOW ROA ► 3.3% AVG ROE ► 2.5% AVG Debt to Equity ► 2.25 AVG Current Ratio ► 1.27 AVG Interest Coverage Ratio ► 1.63 AVG

 

 

 

 

 

 

Lithia Motors, Inc. (NASDAQ: LAD) sells 30 brands of new vehicles, through 108 stores and 187 franchises located in the western part of the U.S. In addition, the company uses a wholesale channel to liquidate less desirable used vehicles, usually acquired as trade-ins, rather than include them in inventory. Approximately 75% of the company's stores are located in cities that do not compete directly with any other franchise dealers selling the same brand, with 85% of dealerships located in smaller markets. Lithia Motors operates through five segments: New Vehicles (58% of revenue), Used Vehicles (27%) Service, Body and Parts (11%) and Finance and Insurance including Fleet and others (4%). Daimler Chrysler is 41% of new vehicle sales, GM is 19% and Toyota is 11%.

Business Overview

Lithia Motors, Inc. is an operator of automotive franchises and retailer of new and used vehicles and services. As of April 10, 2008, Lithia offered 30 brands of new vehicles and used vehicles in 109 stores in the United States and over the Internet.^[1] The company sells new and used cars and light trucks; sells replacement parts; provides vehicle maintenance, warranty, paint and repair services; and arranges related financing, service contracts, protection products and credit insurance for its automotive customers.

Lithia Motors was founded in 1946 and incorporated in 1968. It's two senior executives have managed the company for nearly 40 years. Since the initial public offering in 1996, Lithia has grown from 5 to 109 stores as of April 10, 2008, primarily through its acquisition program that has been accretive to earnings, increasing annual revenues from $143 million in 1996 to $3.2 billion in 2007. In addition, since initial public offering through December 31, 2007, Lithia has achieved compound annual growth rates of 33% per year for revenues and 23% per year for net income from continuing operations.

The company's current new vehicle revenue mix is weighted towards domestic brands at approximately 62%. Management's strategy is to target a more balanced mix between its domestic, import and luxury brands in the years ahead. Approximately 98% of acquisition revenues in 2007 were from import and luxury brands, contributing to an improvement in its import/domestic mix.

Lithia Motors currently offers several customer guarantees that management believes differentiates the company from other competitors in the marketplace. These guarantees are a culmination of several evolution cycles within Lithia that came to fruition in 2007.

For New Vehicles:

• A low haggle “Drive it Now” price, always at or below Manufacturer’s Suggested Retail Price (MSRP);
• Never any Additional Dealer Markup;
• No Documentation Fees, except where state-mandated or controlled; and
• A three-day, 500 mile, no questions asked return policy, including the return of a customer’s trade-in vehicle.

For Used Vehicles

• A low haggle “Drive it Now” price;
• No Documentation Fees, except where state-mandated or controlled; and
• A three-day, 500 mile, no questions asked return policy, including the return of a customer’s trade-in vehicle; and
• A sixty-day, 3000 mile, “if it breaks, we fix it” warranty.

For Service Work

• Service provided on your schedule with no appointment necessary;
• A three-year, 50,000 mile warranty on all repair work, including parts and labor, to ensure a customer will never pay for the same repair twice; and
• A guaranteed price based on the estimate given at the time the car was dropped off.

In 2007 Lithia opened three stand alone used car stores, called L2 Auto. L2 Auto is a web-based sales process that provides a new experience for consumers in the used car market. It offers transparency in every transaction including availability of a broad selection of popular late model used vehicles, clearly marked “negotiation-free” prices based on current market values, a 240 point inspection plan, a sixty-day, 3000 mile “if it breaks, we fix it” warranty, and a three day “no questions asked” return policy.

Franchise Locations

The Industry

At approximately $1.0 trillion in annual sales, automotive retailing is the largest retail trade sector in the U.S. and comprises roughly 7% of the GDP. The industry is highly fragmented with the 100 largest automotive retailers generating approximately 13% of total industry revenues in 2006. The number of franchised stores in the U.S. has declined in the last 10 years from approximately 22,427 stores in 1997 to approximately 21,761 in 2006. In addition to these new vehicle outlets, used vehicles are sold by approximately 50,000 independent used vehicle dealers and through private (person to person) transactions. New vehicles can only be sold through automotive retail stores franchised by automotive manufacturers. These franchise stores have designated trade territories under state franchise law protection, which limits the number of new stores that can be opened in any given area.

Consolidation is expected to continue as many smaller automotive retailers are now considering selling or joining forces with larger retailer groups, given the large capital requirements necessary to operate in today’s retail environment. With many owners reaching retirement age, often without clear succession plans, larger, well-capitalized automotive retailers provide an attractive exit strategy. The recent slowdown in the economy and in retail sales is expected to increase the number of sellers.

Unlike many other retailing segments, automotive manufacturers provide unparalleled support to the automotive retailer. Manufacturers often bear the burden of markdown risks on slow-moving inventory as they provide aggressive dealer and customer incentives to clear aged inventory in order to free the inventory pipeline for new purchases. In addition, an automotive retailer’s cash investment in inventory is relatively small, given floorplan financing from manufacturers. Furthermore, manufacturers provide low-cost financing for working capital and acquisitions and credit to consumers to finance vehicle purchases, as well as pay market-rate prices to their dealers for servicing vehicles under manufacturers’ warranties.

Sales in the automotive sector are affected by general economic conditions including rates of employment, income growth, interest rates and consumer sentiment. In 2007, sales were adversely impacted by the slowing economy, including construction-related industries, and higher gasoline prices. In recent years, domestic manufacturers have seen increasing sales pressure from import and luxury brands, resulting in a reduction in their overall market share. U.S. new vehicle sales were 16.1 million units in 2007 compared to 16.6 million units in 2006. Although manufacturer incentives were lower in 2007 than in 2006, Lithia expects that manufacturers will continue to offer incentives on new vehicle sales during 2008 through a combination of repricing strategies, rebates, lease programs, early lease cancellation programs and low interest rate loans to consumers. To complement the manufacturers’ incentive strategy, Lithia employs a volume-based strategy for its new vehicle sales. New vehicle sales usually decline during a weak economy; however, the higher margin service and parts business typically benefits in the same environment, particularly if extended, because consumers tend to keep their vehicles longer. Automotive retailers benefit from their designation as an exclusive warranty and recall service provider of a manufacturer. For the typical manufacturer’s warranty, this provides an automotive retailer with a period of at least 3 years of repeat business for service covered by warranty. Extended warranties can add two or more years to this repeat servicing period.

Profitability amongst automotive retailers will vary and depends in part on local economic conditions, competition and product mix, effective management of inventory, marketing, quality control and responsiveness to customers. In the industry, new vehicles sales typically account for an estimated 59% of a store’s revenues, used vehicles sales typically account for approximately 29% of revenues and the remaining 12% is typically derived from service and parts sales. Finance and insurance sales are included in the new and used vehicle sales numbers. Industry gross profit margins were 13.6% in 2006.

Automotive retailers have much lower fixed overhead costs than automobile manufacturers and parts suppliers. Variable and discretionary costs, such as sales commissions and personnel, advertising and inventory finance expenses, can be adjusted to more closely match new vehicle sales. Variable and discretionary costs account for an estimated 60-65% of the industry’s total expenses. Moreover, an automotive retailer can enhance its profitability from sales of higher margin products and services. Gross profit margins for the parts and service business are significantly higher at approximately 47%, given the labor-intensive nature of the product category. Gross profit margins for finance and insurance are virtually 100% as they are fee driven income items. These supplemental, high margin products and services provide substantial incremental revenue and net income, decreasing reliance on the highly competitive new vehicle sales.

Financials

References

1. ↑ [http://yahoo.brand.edgar-online.com/displayfilinginfo.aspx?FilingID=5860267-792-446997&type=sect&TabIndex=2&companyid=10497&ppu=%252fdefault.aspx%253fcik%253d1023128 Lithia 10-K 20070