AutoNation (AN) Q3 2023: After Sales Gross Profit Rises 14%, Anchoring Margin Amid Mixed Vehicle Trends

October 27, 2023 | By EarningsIQ Research

AutoNation’s after sales business delivered double-digit profit growth, offsetting margin pressure from moderating new and used vehicle trends. Strategic expansion in recurring revenue streams and disciplined inventory management signal a pivot toward more stable, diversified earnings. Investors should watch the company’s evolving capital allocation and new business initiatives as competitive and macro forces reshape the auto retail landscape.

Summary

• After Sales Drives Margin Stability: Double-digit growth in after sales gross profit cushioned vehicle margin compression.
• Self-Sourcing and Inventory Discipline: Over 90% of used vehicles self-sourced, supporting unit growth and recurring revenue.
• Strategic Expansion Focus: New business lines and finance penetration aim to diversify profit and reduce cyclicality.

Business Overview

AutoNation is a leading U.S. automotive retailer, operating franchise dealerships and standalone used vehicle stores. The company generates revenue through new and used vehicle sales, customer financial services (CFS, in-house financing and ancillary products), and after sales (service, parts, collision repair). Major segments are New Vehicles, Used Vehicles, After Sales, and CFS, with a growing focus on recurring revenue and digital offerings.

Performance Analysis

AutoNation posted low single-digit top-line growth as robust new vehicle sales and record after sales performance offset continued pressure in used vehicles. New vehicle volumes rose 12% year over year, driven by import franchises benefiting from pent-up demand and improved inventory flow, while luxury volumes were flat and domestics up modestly. However, gross profit per vehicle retail (PVR) for new cars moderated as supply normalized, with management prioritizing volume and ecosystem monetization over peak margins.

In used vehicles, unit sales fell 4% year over year but improved 5% sequentially, outpacing the broader market. This rebound was enabled by increased investment in sourcing, particularly through the We Buy Your Car program, and a focus on lower-priced inventory tiers. After sales stood out, with 12% revenue and 14% gross profit growth, reflecting higher repair order values and expanded technician headcount. SG&A rose 7% due to growth investments and marketing, while share count declined over 20% from buybacks, cushioning EPS despite lower operating income.

• Import Franchise Outperformance: Import brands saw over 25% volume growth, unlocking pent-up demand as inventory normalized.
• Used Vehicle Mix Shift: Growth concentrated below $20,000 price point, with higher-priced tiers declining.
• After Sales Margin Expansion: Gross margin in after sales climbed 80 basis points to 47%, benefiting from scale and complexity-driven ticket growth.

Cash flow conversion remained robust, with operating cash flow at 105% of net income, supporting ongoing reinvestment and capital returns. The company’s balance between volume, margin, and ecosystem monetization reflects a deliberate shift toward recurring revenue and customer lifecycle value.

Executive Commentary

Strategic Positioning

1. Recurring Revenue and Customer Lifecycle Expansion

AutoNation is intensifying its push into recurring revenue streams through after sales, finance, and new digital platforms. Initiatives like AutoNation Finance (in-house lending), AutoNation Mobility (micro-leasing), and AutoNationParts.com (e-commerce parts) are designed to capture more share of wallet and increase customer lifetime value, reducing reliance on cyclical vehicle sales.

2. Inventory and Sourcing Optimization

Self-sourcing of used vehicles exceeded 90%, with a disciplined approach to balancing margin and volume. The We Buy Your Car program, trade-ins, and a focus on affordable inventory tiers are central to maintaining throughput and supporting the expansion of AutoNation USA stores. Inventory days supply remains tightly managed, especially for imports (17 days) and luxury (33 days), while domestics are higher (51 days), reflecting market dynamics.

3. Workforce and Capacity Investments

Technician headcount grew over 14%, enabling higher throughput in after sales and supporting double-digit revenue growth. Management leverages existing dealership capacity (bay utilization at 55%) to scale service operations without major incremental CapEx, enhancing operating leverage and customer retention.

4. Capital Allocation Flexibility

Share repurchases remain a core capital return lever, with over 20% reduction in outstanding shares year over year. While M&A opportunities are under evaluation, management has moderated buybacks in light of higher rates and normalized cash flows, prioritizing shareholder value and growth investments over aggressive leverage or international expansion.

5. New Business Model Pilots

AutoNation is piloting new business models such as micro-leasing and mobile repair, aiming to meet evolving customer preferences and diversify revenue. Early results from these initiatives are ahead of plan, though their materiality to earnings remains in the early stages.

Key Considerations

This quarter underscores AutoNation’s strategic pivot from pure vehicle retail to a more diversified, services-centric model. The ability to self-source inventory and drive after sales growth is increasingly critical as vehicle margin tailwinds fade. Management’s holistic approach to deal profitability, integrating CFS and trade-ins, reflects a mature, multi-channel retail strategy.

Key Considerations:

• After Sales as Profit Anchor: Record after sales gross profit and margin expansion are offsetting cyclical vehicle margin risk.
• Inventory Discipline Amid Macro Uncertainty: Tight inventory management, especially for imports, supports pricing and volume resilience.
• Finance Penetration and Product Attach Rates: In-house finance penetration reached one in four ANUSA sales, with stable product attachment rates despite interest rate headwinds.
• Cost Structure and SG&A Investments: SG&A growth reflects targeted investments in marketing, sourcing, and new business lines, with management targeting normalized SG&A as a percent of gross profit below pre-pandemic levels.

Risks

AutoNation faces several risks as the industry normalizes, including potential margin compression in new and used vehicles as supply and competition return to pre-pandemic patterns. Rising interest rates and financing costs could dampen affordability and finance penetration. Labor market tightness remains a challenge, especially for skilled technicians, and macro volatility or a consumer slowdown could pressure volumes. M&A remains opportunistic but subject to high seller expectations and integration risk.

Forward Outlook

For Q4 2023, AutoNation management signaled:

• Continued focus on after sales growth and technician expansion.
• Tight inventory discipline, especially for new and used imports.

For full-year 2023, management maintained a cautious but constructive stance:

• Ongoing investment in recurring revenue businesses and digital platforms.

Management highlighted several factors that will shape results:

• Normalization of vehicle margins as supply stabilizes.
• Scaling of new AutoNation USA stores and integration of finance and services offerings.

Takeaways

AutoNation’s Q3 results highlight the company’s transition toward a more resilient, services-driven model, with after sales providing a critical buffer against vehicle margin headwinds. Inventory discipline and self-sourcing underpin volume stability, while new business initiatives and finance penetration offer long-term optionality.

• Margin Resilience: After sales and finance offsetting vehicle margin normalization, supporting stable earnings power.
• Strategic Diversification: Investments in new business lines and digital channels signal a pivot toward recurring, less cyclical revenue.
• Investor Watchpoint: Monitor the scaling of new business models and capital allocation discipline as industry conditions evolve in 2024.

Conclusion

AutoNation’s Q3 performance demonstrates the company’s ability to adapt to a changing auto retail environment, with after sales and disciplined sourcing anchoring profitability. Strategic investments in recurring revenue and customer lifecycle initiatives position the business for greater resilience, though execution and market normalization remain key watchpoints for investors.

Industry Read-Through

AutoNation’s results reinforce a sector-wide pivot toward recurring revenue and service-centric models as vehicle margin tailwinds recede. After sales growth and technician investment are emerging as key differentiators across automotive retail, with inventory discipline increasingly critical amid macro uncertainty. The company’s experience with self-sourcing, digital expansion, and finance penetration offers a blueprint for peers navigating similar headwinds. Industry participants should closely monitor consumer affordability, labor constraints, and the scaling of new business models as the cycle matures and competition intensifies.

AN Consumer Discretionary Auto Retail After Sales Recurring Revenue Inventory Capital Allocation Self-Sourcing