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Investors Flock to Auto Retail Stock as It Hits New Highs

Sales manager showing car to customer — Photo

Investors have grown worried about the current state of the United States economy, especially now that the ISM Manufacturing PMI index has delivered a 21-month contraction. A reading of 46.8% for July makes it the worst reading in nearly two years. Markets figured that the promise of interest rate cuts from the Federal Reserve (the Fed) was insufficient to justify higher stock prices amid declining fundamentals.

But, despite being part of the consumer discretionary sector, shares of AutoNation Inc. (NYSE: AN) gave investors a reason to stick around, notably after the company released its latest quarterly results. As an initial reaction to the news, the stock rallied by 12.5% to a new all-time high price of $197.2 a share, so there must be a reason for markets to ignore the weakening state of the consumer.

Investors keeping exposure to stocks like AutoNation are worried about inflation, unemployment, and declining new and used vehicle prices. However, the quarter's financial results showed why the stock is still being rewarded with additional upside from markets and Wall Street analysts. Here are some reasons AutoNation stock has delivered a 26.9% year-to-date price performance.

Improving Financial Metrics Justify New Analyst Targets for AutoNation Stock

There are two types of issues that can affect a company's financial quarter: systemic (market or industry-wide issues) or company-specific issues. For AutoNation, it wasn't a company-specific issue that caused its revenue to decline by 2% on the year.

Falling average sales prices (ASPs) per vehicle caused AutoNation's top line to contract. Still, that trend is likely to affect peers like CarMax Inc. (NYSE: KMX), so investors can safely assume that there isn't anything specifically wrong with AutoNation that is causing the financial contraction today.

In fact, management feels so strongly about this that they've allocated up to $350 million in share buybacks as a vote of confidence that the stock is not only on the cheaper end today but also expected to see a brighter future ahead. Funding these buybacks is the $519 million in free cash flow (operating cash flow minus capital expenditures) that AutoNation generated.

While free cash flow has fallen by 2.1% over the past 12 months, the conversion rate matters more—or should matter more—to investors. A conversion rate (free cash flow as a percentage of net income) rising to 147% is significant, showing an improvement in the company's capital cycle and inventory management.

As current inventory values decrease, investors want to see that out of AutoNation as proof that the company is effectively managing this new environment. Of course, others on Wall Street share this satisfying financial metric.

Those at Bank of America decided to boost their price targets on AutoNation stock, this time up to $220 a share as of July 2024, where they previously saw a valuation of $210. To prove these new price targets right, AutoNation stock will need to rally by 21% from where it trades today and make a new all-time high price.

AutoNation's Strong Results Masked by Technical Difficulties

In June 2024, AutoNation, along with other peers in the automotive industry, suffered from a system outage. A hack into CDK Global, an integrated information (IT) company that serves most of the vehicle market with sales, financing, and marketing solutions, caused (again) a systemic issue that masked AutoNation’s actual results.

Ending the quarter with an unexpected incident such as this one could have caused some of the issues that came to light in the company’s quarterly results, which gives investors more reason to watch the stock now that the market is declining due to weak PMI data.

On August 1st, Natixis Advisors decided to boost their stake in AutoNation stock by 4.2% as an initial reaction to the company’s announced quarter. Today, that boost brought the asset manager’s net investment in AutoNation stock up to $2.5 million.

All of this bullish evidence may have caused some bears to bail out of AutoNation stock. Over the past month, its short interest has declined by 4.5%, opening up more room for bullish investors to step in and replace them.

It was also enough for markets to bid up AutoNation stock’s valuation, specifically on a price-to-book (P/B) basis. Trading at 3.6x today will command a premium of over 20% from the automotive sector’s average 3.0x P/B multiple today, and there’s always a good reason for stocks to trade near highs and at premium multiples.

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