The Retail Automotive Industry is comprised of two kinds of companies: those that sell replacement automotive parts and accessories to "do-it-yourself" customers and to commercial "do-it-for-me" clients; and those that sell a wide assortment of new and used vehicles over the Internet and networks of regional or national franchised dealerships.

Economic Considerations

The dealer business tends to be cyclical, since its fortunes are tied to auto industry production levels, gasoline prices, the financial health of the consumer, and the state of the domestic economy. Indeed, dealership groups, even the better managed ones with lean cost structures and extensive ancillary product lines (e.g., parts & service and finance & insurance), tend to struggle during tough economic times.

Parts retailers are also affected by the prevailing macroeconomic environment, but to a lesser degree. These usually less-mature, faster-growing outfits are influenced by their own merchandising & remodeling initiatives and unit development strategies. And they are subject to secular long-term trends, including fluctuations in the older-vehicle population and the number of licensed drivers. (Because of their more attractive growth profiles, parts company stocks, by and large, trade at higher price/earnings multiples than dealer issues.) Notably, about 70% of all parts purchases made by consumers and commercial customers are need-based, rather than discretionary. This helps to shield aftermarket parts retailers from unwelcome economic headwinds.

Important Metrics

Same-store sales, often referred to as "comps", though not noted in the numerical presentation on the Value Line page, is typically discussed by analysts. This metric is the key gauge of revenue performance for both the car-dealer chains and parts retailers. That's because it measures growth at existing showrooms and stores, rather than from newly opened units. Comp trends also provide meaningful insight to future earnings, since most auto-related companies, particularly dealer groups, which operate on slim margins, maintain relatively high fixed-expense bases. When same-store sales are healthy, the bottom line usually climbs with the aid of good overhead leverage. And, when same-store sales slip into negative territory, these specialty retailers often experience a profit squeeze. Some companies are better equipped to weather the effects of a prolonged top-line slowdown than others, however.

Investors in these stocks would do well to focus on retailers with the leanest, most flexible cost structures. Regarding the dealership groups, this means those companies that efficiently manage their inventory positions and have a knack for realizing economies of scale in critical expense areas like vehicle procurement and advertising. Within the aftermarket parts segment, companies focused on improving the supply chain/logistics footprint and driving more sales per square foot of retail space have the best chance of success.

Mergers & Acquisitions

With unit expansion opportunities limited in the mature vehicle retail segment, giant dealerships often endeavor to alter their brand mixes (e.g., boosting their exposure to foreign-made cars and luxury models), diversify their businesses, and wrestle market share away from rivals with the help of acquisitions. Yet, ill-considered or overly aggressive acquisition strategies can easily backfire and have negative consequences. Over the years, countless auto retailers overpaid for properties that ultimately failed to yield much in the way of revenue or cost synergies. Instead, these industry players were saddled with hefty debt obligations, which weighed on their bottom lines and kept them from making needed upgrades to technology systems and dealerships.

Prudent auto retailers tend to be far more selective when it comes to making M&A deals. For starters, well-heeled ones typically wait for difficult economic times and/or disruptive shakeout periods in the sector, when they can gobble up regional chains and mom-and-pop shops on the cheap. Additionally, they usually target distressed assets that will be easy to integrate, especially from a geographic and management-style standpoint, into existing operations. This enables the dealers to quickly realize economies of scale.

Unit Development

Acquisitions are not high on the agendas of the aftermarket parts retailers, since these companies are blessed with plenty of organic growth possibilities. In fact, in recent years, the other leading participants in this segment of the market have been bolstering their top- and bottom-line results by opening new stores at a brisk clip. This trend will probably persist for some time to come, as there are still numerous underserved markets across the country ripe for expansion. Some of the parts retailers do have balance sheets that are as leveraged as those of their auto-dealer counterparts, however, prohibiting them from being too active on the unit development front. This is certainly something for investors to consider before making a commitment.

Concluding Thoughts

Auto-related retailers are impacted by a whole host of factors, from the macroeconomic to the company- and sector-specific. That said, investors should pay special attention to same-store sales and margin trends, cash/debt levels, and acquisition/unit development track records. Good judgement in the executive suite, while sometimes hard for investors to measure, is also an essential ingredient for success in this space. Indeed, given the volatile nature of the Retail Automotive Industry, managers frequently need to be nimble in order to keep their firms on a healthy growth track.