Elevator Pitch
I have a Buy rating for Sonic Automotive (NYSE:SAH) stock.
I previously wrote about the company’s near-term prospects and capital allocation in my Nov. 14, 2023 update. This article evaluates the growth runway for SAH’s pre-owned vehicle business (EchoPark) and the expectations for its future share buybacks.
My decision is to retain a Buy rating for Sonic Automotive. EchoPark has solid growth potential for the long run, and it has an impressive share buyback track record.
Q1 EPS Beat
Sonic Automotive’s normalized earnings per share or EPS increased by +2.3% YoY to $1.36 in the first quarter of the current year, as per its most recent quarterly results disclosure last week. This was +4.8% ahead of Wall Street’s consensus Q1 EPS forecast of $1.30.
In my mid-November 2023 write-up, I highlighted that “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.” Indeed, it was EchoPark which made the difference for SAH in the most recent quarter.
Normalized EBITDA for the EchoPark segment rose by +120% YoY to $7.3 million for Q1 2024. For comparison, EchoPark suffered from a substantial EBITDA loss of -$36.9 million a year ago in Q1 2023.
Sonic Automotive stressed in its first quarter earnings press release that EchoPark’s actual Q1 performance “exceeded previously issued target for an expected return to breakeven EchoPark Segment adjusted EBITDA.” At the company’s Q1 2024 results briefing, SAH explained that “the reductions to our store footprint” for EchoPark which began one year ago enabled it “to better allocate inventory across the platform, driving higher unit sales volume per rooftop, better variable GPU (Gross Profit Per Unit).”
I elaborate on EchoPark’s long-term growth potential in the next section.
EchoPark Has Good Growth Prospects
Looking beyond the first quarter, my opinion is that EchoPark will continue to be a significant growth driver for SAH in the long term.
Firstly, Sonic Automotive’s EchoPark segment could benefit from industry consolidation. The pre-owned vehicle market’s weakness driven by “inventory sourcing challenges” and “rising used car prices” as mentioned in an April 2024 Fitch Ratings research article has led to the exit of some of EchoPark’s competitors. Sonic Automotive emphasized at its first quarter earnings call that EchoPark is “one of the few remaining nationwide used vehicle retailers” which translates into a “tremendous long-term opportunity for this brand.”
Secondly, the supply/demand dynamics for the pre-owned vehicle market are expected to turn more favorable after next year. SAH cited forecasts from J.D. Power in its investor presentation which predicted that the supply of pre-owned vehicles will bottom out in 2025. Sonic Automotive outlined its views in its investor presentation that EchoPark will be a beneficiary of “gradual expansion of used vehicle supply” for 2026 and beyond that should increase “consumer demand and higher retail sales volume” for its pre-owned vehicle unit.
Thirdly, there’s room for SAH’s EchoPark business to expand its reach. EchoPark’s “population coverage” in terms of its visibility among U.S. vehicle buyers in late 2022 was revealed to be slightly more than 50%. I have noted earlier in this article that Sonic Automotive has been shrinking its network of stores since early 2023, so it’s reasonable to assume that EchoPark’s current “population coverage” is likely to have remained close to 50% with a temporary pause on expansion. Moving ahead, SAH drew attention to EchoPark’s “long-term goal to reach 90% of the U.S. population” in the company’s latest investor presentation.
In the subsequent section, my focus is on SAH’s share repurchases.
Spotlight On Capital Return
Sonic Automotive noted the company’s “commitment to returning capital to stockholders via share repurchases” at its Q1 2024 earnings call.
Between the first quarter of 2020 and the first quarter of 2024, SAH lowered its share count by more than a fifth through buybacks. As of March 31, 2024, Sonic Automotive still had $260 million (source: investor presentation) left from its current buyback authorization (with no expiry date), which is equivalent to 12% of its market capitalization.
The average annual amount of monies that SAH spent on share repurchases in the past four years (2020-2023) was $151 million. If the company allocates $151 million to buybacks in 2024, this will translate into a potential buyback yield of 7.2%. In comparison, Sonic Automotive’s consensus dividend yield for the current year is 1.9%.
In other words, there’s the potential for Sonic Automotive to offer a shareholder yield at the high-single digit percentage level (7.2%+1.9%) this year, assuming that it does a meaningful amount of buybacks for 2024 in line with the historical average.
Downside Risks
The key risk factors for SAH are related to its pre-owned vehicle business and share buybacks.
Sonic Automotive will be a much less attractive investment candidate with a lower shareholder yield if the company executes on a limited amount of share repurchases this year. In the absence of buybacks, SAH’s expected shareholder yield with dividends alone is only a low single-digit percentage.
Also, SAH’s future results might be below expectations, assuming that its pre-owned vehicle business EchoPark underperforms. EchoPark’s better-than-expected operating profitability was the major reason for Sonic Automotive’s Q1 bottom line beat. There’s no assurance that EchoPark’s good financial performance can be sustained in subsequent quarters, which is also dependent on the health of the overall used car market.
Final Thoughts
I remain bullish on Sonic Automotive for two reasons. Firstly, the company’s pre-owned vehicle business has favorable growth prospects. Secondly, SAH has the potential to offer a high-single digit percentage shareholder yield on the assumption that its 2024 repurchases are on par with the 2020-2023 average.