Sonic Automotive Offers Significant Upside Potential for Long Term Investors

Summary

SAH Q1 2016 results showed improved gross margins and EBITDA has reached $60.38 million

In Q1 2016, SAH sold 29,333 used vehicles, which is 4.3% higher compared to the same quarter last year

Despite a slowdown in the US economy poses challenges in top line, the stock price was highly oversold

The implied price of SAH is at $33.33, which offers investors a 77.67% upside potential based on the current market price of $18.76 per share.

Company Overview

As an automotive retailer of new and used cars, Sonic Automotive Inc (NYSE: SAH) operates in the United States and operates two distinct segments, franchised dealerships and specialty retail store chain called EchoPark.

Sonic Automotive Inc’s franchised dealerships are engaged in providing traditional services like selling new and used cars, and providing replacement parts and offering after sales services such as repair and maintenance services. On the other hand, the EchoPark segment consists of a range of pre-owned specialty retail stores that offers customers a hub to search for vehicles, buy and sell, service their cars.’

As of May 1, 2016, Sonic Automotive Inc had a respectable market capitalization of $851.14 million. With a 52 weeks’ stock price range of $15.64 to $25.66 per share, currently it is trading at the lower end of the range, at $18.76 per share.

The Market May Have Been Oversold in April

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Figure 1: Historical Correlation Between Revenue and Stock Price of Sonic Automotive Inc

If we take a closer look at Sonic Automotive Inc’s quarterly revenue chart, we can see that its stock price has closely followed its quarterly revenue curves over the last ten years. As the revenue of Sonic Automotive Inc started going down after the start of the great recession in 2008, its stock price fell to record lows. However, as the US economy gradually started recovering in 2009, and the revenue started to up, the stock price also gradually went up to pre-2008 levels.

Over the last three quarters, Sonic Automotive Inc’s quarterly revenue has gone down from $2.5 billion in Q3 2015 to $2.235 billion in Q1 2016, representing a 10% decline. However, during this same time period, the stock price of Sonic Automotive Inc has gone down from $21.20 in the end of Q3 to $16.38 on April 8, 2016, representing a 22.73% decline.

Compared to the revenue decline, the stock price declined by almost twice. We believe Sonic Automotive Inc stock was oversold.

Review of Q1 2016 Financial Result

On April 26, 2016, Sonic Automotive Inc released its Q1 2016 earnings, which showed that the company has made net earnings of $14.46 million based on its total revenue of $2.235 billion.

Capital Cube reported that Sonic Automotive Inc’s gross margins has improved to 14.62% from 14.25% compared to Q1 2015. However, the EBITDA margins have gone down slightly to 2.72% from 2.87%.

During Q1 2016, Sonic Automotive Inc also made new grounds with the used car sales figure. According to a BizJournals article, Sonic Automotive Inc sold 29,333 used vehicles in the first three months of 2016, which is up 4.3% compared to the Q1 2015.

As the stock was already oversold, the positive news from Q1 2016 financials gave the bulls a good reason to push the stock price up.

On April 25, the stock Sonic Automotive Inc was trading at $16.52 per share by the end of April 26, it climbed to close at $19.04, representing a sharp increase of 15.25% overnight.

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Figure 2: Diverging EBITDA and Net Profit of Sonic Automotive Inc

While the recent macroeconomic factors could be held responsible for the decline in revenue, it is worth noting that Sonic Automotive Inc’s EBITDA has gone up since the start of 2016. However, with an increasing EBITDA and cash from operations, which stood at $103.64 million in Q1 2016, the decline in net profits only indicates internal management deficiency.

Conclusion

The first thing is that Sonic Automotive Inc will be opening EchoPark outlets in the Carolinas and Texas markets by 2017. While it will take more than a year to add the revenue from these two large markets in the balance sheet, we are optimistic that expanding its business in these states will help secure the long-term future of the company.

In the short term, we are bullish because the management has been buying up shares. The repurchasing program has so far reduced the outstanding share count to around 46 million, which has directly provided ample technical support to the price at key levels in the last few months.

Capital Cube mentioned that their implied price of Sonic Automotive Inc stock is $33.33. At the current market price of $18.76, this implied price offers an 77.67% upside potential to secondary investors. While we don’t expect it to happen overnight like last week, we believe that this target price would be reached in due course over the course of next year if things go as planned.