Elevator Pitch
My rating for Sonic Automotive, Inc. (NYSE:SAH) shares is a Buy. In my prior August 7, 2023 write-up, my focus was on the guidance for SAH’s pre-owned vehicle business and the company’s stance on allocating excess capital.
In the current update, I draw attention to Sonic Automotive’s EBIT outlook for the final quarter of this year, and highlight potential M&A activity and share buybacks. SAH’s Q4 2023 EBIT is expected to be better than for Q3 2023, and the company is likely to be more aggressive on share repurchases and acquisitions in the future. This explains why I have raised my rating for Sonic Automotive from a Hold earlier to a Buy now.
Expectations Of QoQ EBIT Growth For SAH In Q4
SAH is expected to report its fourth quarter financial results in mid-February next year. The Wall Street analysts have become increasingly optimistic about Sonic Automotive’s Q4 2023 financial performance.
Having reported its Q3 2023 results late last month, the sell side’s consensus full year FY 2023 EBIT forecast was revised upwards by +6.6% (source: S&P Capital IQ) since the beginning of last month. Despite challenging macroeconomic conditions, the market sees SAH registering positive sequential growth in operating profit for the fourth quarter of this year. In specific terms, the sell side analysts are projecting that Sonic Automotive’s EBIT will increase by +2.3% QoQ from $130.3 million in the third quarter of the current year to $133.3 million for Q4 2023. This also points to an implied +10 basis point operating margin improvement between Q3 2023 and Q4 2023.
In my view, there are a number of positive factors supporting the market’s expectations of a QoQ increase in Sonic Automotive’s operating income for the fourth quarter of 2023.
Firstly, a lack of inventories has hurt SAH’s new vehicle sales performance in prior quarters, but this is expected to be less of an issue for the fourth quarter of this year. Sonic Automotive revealed at its Q3 2023 earnings briefing that its new vehicle inventories are projected to surpass the 10,000 unit mark for the first time in the past four years in Q4 2023.
Secondly, Sonic Automotive’s key franchise brand, BMW (OTCPK:BMWYY), which represents more than a fifth of the company’s top line, is likely to perform well for Q4 2023. At its third quarter results call, SAH noted that it has a healthy “26-day supply of BMW EVs (Electric Vehicles)”, and it shared that the profitability of BMW EVs is “in the same range as an ICE (Internal Combustion Engine) vehicle.” In other words, Sonic Automotive has sufficient BMV EV inventories available for sale, which carry similar profit margins as their ICE counterparts.
Thirdly, EchoPark, SAH’s loss-making pre-owned vehicle segment, has been a drag on the company’s aggregate earnings in the past, but the profitability outlook for EchoPark is getting better. EchoPark’s normalized EBITDA loss narrowed substantially from -$31.8 million in Q2 2023 to -$5.2 million for Q3 2023. Looking ahead, Sonic Automotive guided that EchoPark’s “EBITDA should continue to improve as more of the SG&A (Selling, General & Administrative optimization) moves that we made sink in.”
Sonic Automotive’s Potential Upside Relating To Acquisitions And Capital Return
Previously, I expressed my concerns that Sonic Automotive “doesn’t seem to be as aggressive on buybacks and acquisitions as what I would have hoped for” in my early August article. In that write-up, I specifically made reference to SAH’s earlier comments at its Q2 2023 earnings call in July this year that “cash is king when you have uncertainty with economic conditions.”
But it appears that Sonic Automotive has moved away from its prior conservative stance on capital allocation, and it seems to be willing to utilize a greater proportion of its capital for value-accretive initiatives. This might be a significant source of upside for SAH’s shares in the near future.
At the most recent Q3 results call, SAH didn’t disagree with a sell-side analyst’s assertion that the company is expected to devote “little bit less to EchoPark on time and capital” considering that the pre-owned vehicle business’ profitability improvement has been on track. Sonic Automotive highlighted that the company will “look at the opportunities, both in the franchise and in powersports” businesses, especially “good acquisitions that make sense.” At the same time, the company also noted that “we certainly believe that our shares are (trading at) a great value”, and mentioned that it has “bought back 9% of the outstanding shares” in 2023 year-to-date.
SAH’s latest management commentary suggests that the company could engage in M&A deals to boost its future top line expansion. Separately, Sonic Automotive is also likely to repurchase its shares at a faster pace in view of its shares’ undervaluation based on the company’s management comments. As a reference, SAH is valued by the market at an undemanding consensus forward next twelve months’ normalized P/E multiple of 7.1 times (source: S&P Capital IQ), while the company boasts a strong FY 2025-2027 normalized EPS CAGR projection of +24.6% as per S&P Capital IQ data.
Closing Thoughts
I expect Sonic Automotive to be more active with regard to capital return and capital investment in the foreseeable future. I also see SAH delivering sequential growth in EBIT for the fourth quarter of this year. These are the factors supporting my Buy rating for SAH.
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