Lithia Motors, Inc.

Moat: 2/5

Understandability: 3/5

Balance Sheet Health: 3/5

Lithia Motors, Inc. is a large US-based automotive retailer offering a wide selection of new and used vehicles, along with related services like financing, maintenance, and insurance, primarily in the United States.

Investor Relations Previous Earnings Calls

The moat, understandability, and balance sheet health scores reflect a conservative evaluation to ensure a margin of safety in any assessment.

Business Overview: Lithia Motors, Inc. (LAD) operates as an automotive retailer, primarily in the United States, offering new and used vehicles. But its operations extend far beyond the sale of cars, encompassing a range of services that contribute to the company’s integrated approach to vehicle ownership.

  • Revenue Distribution: * New vehicle sales * Used vehicle sales * Service, body, and parts * Finance and insurance

These activities are not always segregated clearly, instead some units perform multiple tasks at the same time, and some parts are intertwined within the whole business.

  • Industry Trends:
  • Consolidation: The automotive retail market is seeing consolidation, with larger players acquiring smaller dealerships. This is due to the complexities of the industry and the benefits of scale.
  • Digitization: Increasingly, consumers are using the internet in their shopping process, and digital retailing is becoming a very important aspect of the industry.
  • Supply Chain Disruption: In recent times the industry has been affected by shortages of inventory due to supply chain issues, but the demand remains high.
  • Margins: New vehicle sales margins have been volatile in recent years and are under pressure due to high prices, limited discounts, and manufacturer incentives; however, used vehicle margins have been consistently strong, while finance and insurance have held strong margins.
  • Competitive Landscape: The automotive retail industry is intensely competitive, where manufacturers often determine pricing and production volume, while retailers fight to maintain margins. The shift to online retail is also creating disruption in traditional dealerships.
  • What Makes LAD Different: The company has a diverse range of products and services that span the entire vehicle ownership lifecycle. Through its proprietary Driveway platform, they offer an integrated solution for online sales, finance, and service. Also their geographical reach is relatively wide with 278 locations in the US and 3 in Canada as of Dec 2022, which allows them to create some benefits of scale.

Financials In-Depth:

  • Revenue: Total revenue for the nine months ended September 30, 2024 was $20.4 billion, an increase from $17.6 billion for the same period of 2023. This includes the new and used retail, service, parts, and finance businesses.

  • Sales Growth: Revenue grew due to acquisition activity and higher unit sales and average pricing.

  • Margins: Gross margins were 15.6% for the first nine months of 2024, compared with 15.1% in the same period of 2023.
    • Gross Profit Increase: The company cited increased gross profit for its new vehicle retail business, finance and insurance and for its service and parts operations for increases in their gross profit.
  • Operating Expenses: SG&A expenses were $1.2 billion in the first 9 months of 2024, compared with $1.0 billion in the first 9 months of 2023.

  • Increase in Expenses: The company cited growth initiatives as a reason for the increased SG&A costs in the periods reported.

  • Net Income: Net income was $633.3 million for the first nine months of 2024, a decrease from the $650.1 million reported in the same period of 2023, primarily due to high acquisition costs.

  • Cash Flows: Net cash from operating activities was $2.7 Billion for the first nine months of 2024 compared with $264.8 million in 2023 and the main reason for higher cashflow was growth in net income.

  • Liquidity: As of September 30, 2024, the company had $1.4 billion available in cash and committed credit facilities.

  • ROIC: Return on invested capital (ROIC) for the third quarter of 2024 was 14%, which is below its average performance over the last few years.

Latest Information, Concerns / Controversies and Problems:

  • Acquisition Activity: LAD has been growing through strategic acquisitions. In the last year, they have acquired multiple companies as part of their growth strategy. This increases revenue, but also creates integration challenges and higher short term costs.

  • Used Vehicle Sales Decline: Even though used vehicle sales saw higher margins YoY, the volume of sales has decreased.

  • Management on High Interest Rates: They said that while high interest rates have caused some changes in demand for new vehicle sales, that they are not too worried about the long term. However, some of the financing business margins are affected.
  • Management on Inventory: Supply chain issues and inventory shortages have mostly resolved, and the company is managing inventories well. The company added that inventory levels have been intentionally higher than previous years. * Management on New Vehicle Supply: Automakers have started to make some improvements in vehicle production. Management is expecting increases in production to increase their sales in 2024.
  • Management’s View of Macroeconomics: Management is continuing to keep a close eye on macroeconomic conditions, but believes they are well-positioned to weather any uncertainty. * Management on Future Guidance: Management did not give a specific guidance about 2024 earnings due to economic uncertainty.
  • Share Repurchase program: The company has $925 million remaining for its stock repurchase program. They will continue repurchases as opportunity arises.

Moat Analysis: 2 / 5 Lithia Motors does have a narrow moat based on some tangible competitive advantages.

  • Intangible Assets - Brands: The company doesn’t have any significant competitive advantage on brands since they are selling a lot of different car brands. However, their own brands such as Driveway, are not yet established.
  • Switching Costs: The company does not benefit from switching costs since customers are not incentivised to stay with them. Customers care about the car price, so they buy on that basis.
  • Network Effects: They do not benefit significantly from a network effect. The car industry isn’t about network, it is about a product with good reviews and lower costs.
  • Cost Advantages: The company’s main moat is their extensive network of stores, which helps them lower costs in servicing and deliveries. They are very geographically dispersed which increases their value, but is easily replicable, so cannot provide a very wide moat.

Given these factors, the economic moat for LAD can be classified as narrow.

Risks to the Moat and Business Resilience:

  • Economic Downturn: A decrease in consumer demand due to economic changes can lead to significant losses.
  • Changes in Consumer Preferences: Shifts away from traditional retail or towards specific types of vehicles, like electric vehicles, can weaken LAD’s competitive position.
  • Supply Chain Disruption: Continued supply chain issues and vehicle shortages can reduce their revenue and profitability.
  • High Leverage: Although the debt is not unmanageable, a large reliance on debt could pose problems during an economic downturn.
  • Acquisition Integration Risk: There may be some issues in the execution of their acquisition strategy, leading to high costs and management distraction.

Understandability Rating: 3 / 5

The business model of LAD is relatively straightforward since it is a car dealership; however, to calculate the intricacies of the business model, financials, earnings, etc requires expertise. Their acquisitions do increase complexity. Overall, I’d rate it a 3.

  • The core business model is relatively easy to grasp.
  • The complexity of financial reporting combined with multiple acquisitions makes it slightly difficult to follow the numbers and derive conclusions.

Balance Sheet Health Rating: 3 / 5

The company’s balance sheet is ok, but it’s not pristine. They carry a significant amount of debt.

  • Debt Levels: The company uses a significant amount of debt to finance its operations and acquisitions, which can put them at risk of financial distress.
  • Liquidity: The company has a good amount of liquidity and current assets that can help them during any downturn.
  • Leverage: Although the debt level is a bit high, this has also helped them grow revenues and earnings significantly over the last few years.

Based on this, I’d give the company a score of 3.