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US mega-dealers lose some of their investor appeal

A Business Week report suggests US dealer group margins are suffering, debts have increased from acquisitions, and stock values are starting to slide.

Big US groups like AutoNation Inc and United Auto Group have built revenue growth at rates as high as 30% p.a. from acquisitions of over 1,000 independent dealers in the past six years, and dealer group stock prices have risen, as in the UK, on the expectation of scale benefits.

AutoNation soared 45% in the past year, to $19 a share. United Auto and Asbury Automotive Group shares more than doubled to $30 and $17 a share respectively. Group 1 Automotive, Sonic Automotive and Lithia Motors shares each rose by at least 50%.

But Business Week says the companies' shares are beginning to fall, as most big groups are shown to have lower net margins than independent dealers. AutoNation's share price has fallen by about 13% since September 2003. Many of the big quoted groups make only a 5%-6% return on assets, while paying between 6% and 10% on the money they borrowed to buy more dealerships. The better independent dealers earn a net margin before taxes of roughly 2.6%, according to consultants NCM Associates Inc.;only AutoNation among the big six quoted groups does better.

AutoNation, the largest of the six big US dealer groups founded in 1996 by H. Wayne Huizenga, has begun to retrench somewhat. It has nearly $20 billion in annual revenue. (United Auto is next-biggest, with $9 billion in revenue.) In 2003 AutoNation's acquisitions added $300 million in annual revenue, compared to $500 million in 2002, and AutoNation chairman and CEO Michael J. (Mike) Jackson is quoted as saying, "The low-hanging fruit is pretty much gone."

AutoNation's cost-cutting efforts added some $43 million to profits last year, which rose to $479 million from $382 million in 2002, though its revenue stayed more or less static.

The six listed dealer groups acquired 95 dealerships in 2003, adding $2.5 billion to their top lines. But that was less than half the $5.2 billion in new revenue from acquisitions in 2002.

Manufacturers in the US are permitted to restrict dealer ownership and veto the quoted companies' acquisitions, and in several cases, are doing so. Manufacturers generally believe, says Business Week, that the big groups' savings on advertising and consolidated back-office expenses and inventory interest aren't big enough to offset the cost of extra management layers or the regulatory costs of being public companies.

But the biggest drag on the big six groups' margins is the $3.1 billion in debt they have acquired to fund their acquisitions. It is little wonder, says Business Week, that Standard & Poor's rates the bonds of every dealer group as 'junk', though AutoNation does have an investment-grade corporate line of credit.

The magazine notes that under GAAP accounting rules, groups are able to report earnings per share that exclude losses from under-performing dealerships if they report these as being up for sale and therefore classify them as discontinued operations – even if they still own the outlets. By excluding such losses, Sonic was able to highlight earnings per share of $2.07 for last year, though it also reported net income of $1.69 per share.

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