Lithia Is One of Our Favorite Names in the Auto Dealer Space

Strategist

David Whiston

Lithia Motors' business model is strong because it is the only large publicly traded dealer operating in rural markets. These markets are unattractive to larger public dealers, as their management teams have no interest in small cities and they have import and luxury brand mixes more favorable to suburban markets. Nationwide, many Lithia brand stores have no competitors within 100 miles, giving Lithia pricing power.

The October 2014 DCH acquisition transformed Lithia, beginning a strategy of expanding in large metro areas. Lithia's management is also retaining its rural market focus, which we like, while moving into new segments such as a captive finance arm, insurance, electric vehicle charging, fleet management, the UK, dealer management software, and power sports, RVs, or heavy equipment. Management's long-term target is $75 billion-$100 billion in sales and earnings per share, or EPS, of as much as $200, up from $11.76 EPS in 2019, while creating an unreplicable ecosystem per CEO Bryan DeBoer. Massive acceleration in acquisitions has occurred with acquired annual revenue of at least $2 billion-$4 billion, and Driveway, a national digital brand launched in fall 2020, expanding the firm's reach far beyond its stores. Driveway enables customers to buy new and used vehicles online or in person via no haggling, home delivery anywhere in the US, and a seven-day, 400-mile, money-back guarantee. It's a good strategy to keep Lithia competitive with digital upstarts like Carvana.

Lithia's used-vehicle strategy focuses on what the company calls value autos, boosting gross margins. These are vehicles priced to customers in the $15,000 range, generally up to 20 years old, with more than 80,000 miles. The company seeks $2,000 profit on each vehicle regardless of make or age, so value vehicles can have very high margins.

Lithia buys underperforming dealers rather than unprofitable ones. As consolidation continues in the auto dealership industry, we think Lithia will have no shortage of acquisition candidates but starting in 2024 management said it will emphasize buybacks as well as acquisitions. Since July 2020, Lithia has acquired over $23 billion in annual revenue.

Business Strategy & Outlook

We assign Lithia a narrow economic moat rating. The firm not only enjoys the same narrow-moat traits as the other public dealers (cost advantage and intangibles), but also has the distinctive rural market focus that gives it no formidable competition for a given brand. State franchise laws are another source of the sector's moat, and Lithia's rural focus makes this advantage even more powerful than its competitors by giving the company efficient scale. Franchises are difficult to terminate even in an OEM bankruptcy, and laws exist stating that a brand cannot have a rival store within a fixed distance of an existing one. This distance plays right into Lithia's business model: If one goes just outside towns such as Fairbanks, Alaska; Midland, Texas; or Billings, Montana, there is little to no development.

Despite the DCH deal and subsequent purchases moving the company into large metropolitan markets, management is retaining its rural strategy. Lithia can now pursue growth in both rural and metro areas, so we see no reason to change our moat rating because of the acquisition. Lithia's competitors operate in large metro areas and also have narrow moats, just not from efficient scale, as Lithia does with its rural market niche. Other dealers' moats come from cost and intangible advantages, which Lithia also shares.

We think the dealer sector is the best business in the automotive supply chain. The public dealers can centralize back-office operations and generate far more volume than a small dealer, which brings scale. Dealers have no burdensome retiree expenses, and the large public dealers are not dependent on the health of one brand. The dealers enjoy mid- to high-single-digit gross margins on new vehicles and 100% gross margins on financing and insurance. We think the best source of competitive advantage is the parts and service operations. Many customers bring their vehicle to the dealer for servicing because the vehicle is either under warranty or because the dealer is close to home and has the factory parts and expertise to service the vehicle. Once vehicle owners know a dealer, we think they are likely to keep going back to the dealer for service. The dealer knows the vehicle, and comparison shopping for repair work is very time-consuming, as the customer has to bring the vehicle to each shop to get a quote.

These logistics create inelasticity of demand, which in turn creates pricing power for the dealer and is a source of excellent profit in good times and bad. In fact, during a downturn in new-vehicle sales, dealers generally report higher gross margins, owing to a favorable mix shift, but then report lower operating margins because of selling, general, and administrative expense deleveraging. Excluding large impairment and restructuring charges, dealers can still report positive EBIT even in a severe recession. Although most dealerships are good businesses, we think the large publicly traded dealers are best positioned for growth since these firms can be the most flexible in changing brand mix, and their growing size means they can achieve working-capital efficiencies by moving inventory around their store base. Many small-business owners are choosing to exit or sell because they cannot get the scale on a variety of expenses compared with large dealer groups. About 92% of dealer owners own between one and five stores per the National Automobile Dealers Association, so we see a long growth runway for consolidators such as Lithia.

Narrow

Economic Moat

Lithia Motors

Lithia Motors, Inc. engages in the operation of automotive franchises and retail of new and used vehicles. It operates through the following segments: Domestic, Import and Luxury. The Domestic segment consists of retail automotive franchises that sell new vehicles manufactured by Chrysler, General Motors, and Ford. The Import segment consists of automotive franchises that sell new vehicles manufactured by Honda, Toyota, Subaru, Nissan, and Volkswagen. The Luxury segment includes retail automotive franchises that sell new vehicles manufactured by BMW, Mercedes-Benz, and Lexus. The company was founded by Walt DeBoer and Sidney B. DeBoer in 1946 and is headquartered in Medford, OR.

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Lithia Motors posts record revenue growth, eyes profitability in 2023

Lithia Motors (LAD) delivered strong financial performance in 2022, with robust revenue growth and strategic acquisitions driving expansion and profitability.
Challenges such as declining new vehicle GPUs and affordability issues in the value auto segment require targeted strategies for sustainable growth.
Opportunities lie in Driveway Finance's growth potential, market recovery in used car volumes, and cost-saving initiatives, positioning LAD for continued success.
Overall, LAD's focus on balancing growth and returns, alongside a strategic outlook for 2023, underscores its commitment to shareholder value and sustainable expansion.

Lithia Motors & Driveway report Q1 growth, eye $50B revenue by 2025

Lithia Motors & Driveway show resilience with revenue growth and strategic acquisitions. DFC's focus on high credit quality contracts and profitability by 2024. Company optimistic about achieving ambitious revenue and EPS targets by 2025.

Lithia Motors reports strong Q2 earnings, eyes $50B revenue by 2025

Lithia Motors is on track to meet its 2025 revenue target of $50 billion, emphasizing shareholder value and strategic acquisitions. The company faces challenges in inventory management and pricing pressures but sees opportunities in sustainable vehicle sales and e-commerce growth.

Lithia Motors reports robust Q3 earnings, eyes tech-driven growth

Lithia Motors and Driveway show strong revenue growth and profitability in Q3. Focus on enhancing customer experience and expanding market share through tech investments.
Challenges include maintaining credit standards, variable sales performance, and increasing Driveway's post-sale business. Opportunities lie in pending acquisitions, tech investments, and customer experience.
Despite challenges, Lithia remains confident in guidance and aims to achieve 2025 targets. The company's performance and strategic focus position it well for future growth and market share gains.

Lithia Motors reports robust Q4 earnings, eyes $50B revenue target

Lithia Motors' strong financial performance in Q4 and full-year 2023, driven by new vehicle sales and acquisitions, positions the company for continued growth. Challenges in used vehicle sales and GPU dynamics require strategic adjustments for profitability. Opportunities lie in achieving revenue targets, enhancing customer experiences, and improving leasing penetration.

Lithia Motors reports robust Q1 revenue growth and profitability strategies

Lithia Motors delivered strong revenue growth and maintained a focus on profitability through cost-cutting measures and strategic initiatives. Driveway's progress towards profitability and online sales channel success are notable highlights.
Challenges include managing SG&A costs, optimizing operations in the U.K., and ensuring efficient marketing spend for sustained growth. Opportunities exist in enhancing profitability, customer experience, and operational efficiency.
Overall, Lithia Motors and Driveway are poised for growth through market share expansion, cost reductions, and customer-centric strategies. Balancing challenges with opportunities will be crucial for sustained success in the future.

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