2016 CFA Institute Research Challenge SAH 1 Appalachian State University Student Research SONIC AUTOMOTIVE, INC. (SAH) Industry: Large Dealership Groups in the US HIGHLIGHTS One Sonic-One Experience (OSOE) & EchoPark - SAH’s risky and capital intensive projects, OSOE and EchoPark, will not provide the competitive advantage that the company currently lacks. Both of SAH’s initiatives have a long timeline for completion, and we do not have faith that current management will stay on schedule due to their record of delays and missed earnings. To date, these initiatives have not shown definitive evidence of profitability and we believe SAH will have continued difficulty implementing these strategies because of delays, stiff competition, and weak brand power. Cyclicality of Industry - SAH is vulnerable to an economic downturn due to the cyclical nature of automotive sales, expense burdens from key initiatives, and their performance during the last recession. Based on historic trends in the industry, a slowdown of automotive sales is likely in the near future. Since beginning development of EchoPark and OSOE the industry has been recovering from a downturn in automotive sales caused by the Great Recession. Since then, record high industry-wide sales have helped offset the negative near-term effects of SAH’s high capital expenditures. We believe that when the next industry slowdown occurs, the reductions in automotive sales and large depreciation charges will have a compounding impact that will cause a significant reduction in EPS. Valuation - We believe SAH is a SELL with a target price of $18.19. This provides a -1.12% total price reduction from the January 22, 2016 closing price of $18.40. Our target price was calculated using an equal weighting of discounted cash flow and P/E valuation metrics. ($ in 000s) 2012A 2013A 2014A 2015E 2016E 2017E 2018E 2019E 2020E Revenue 8,365,468 8,843,168 9,197,099 9,655,493 9,919,062 10,193,298 10,481,377 10,802,199 11,127,415 EBIT 240,402 234,603 233,613 215,904 245,483 262,883 280,481 290,527 306,296 Net Income 89,101 81,618 97,217 85,859 100,902 100,116 102,795 104,452 112,272 EPS 1.48 1.54 1.85 1.71 2.08 2.12 2.20 2.24 2.41 Dividends 0.10 0.10 0.10 0.11 0.15 0.14 0.15 0.15 0.16 Return on Assets (%) 3.21 2.67 3.05 2.61 2.91 2.77 2.73 2.68 2.79 Return on Equity (%) 16.92 13.30 14.58 12.34 13.39 12.26 11.50 10.52 10.16 Recommendation Price as of 1/22/2016 12 Month Price Target Price Reduction SELL $18.40 $18.19 -1.12% This report is published for educational purposes only by students competing in the CFA Institute Research Challenge. -100% -50% 0% 50% 100% 150% SAH S&P 500 Russell 2000 Market Profile (Class A Shares) 52 Week Range $16.77-$26.60 Beta 1.874 Dividend Yield 0.82% Market Cap $909.5M Shares Outstanding 37.8M Institutional Holdings 35.4M Insider Holdings 2.07M Debt to Assets 64.0% Debt to Equity 305.4% Exchange NYSE SAH Return Comparison
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2016 CFA Institute Research Challenge SAH
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Appalachian State University Student Research
SONIC AUTOMOTIVE, INC. (SAH) Industry: Large Dealership Groups in the US
HIGHLIGHTS One Sonic-One Experience (OSOE) & EchoPark - SAH’s risky and capital intensive projects, OSOE and EchoPark,
will not provide the competitive advantage that the company currently lacks. Both of SAH’s initiatives have a long
timeline for completion, and we do not have faith that current management will stay on schedule due to their record of
delays and missed earnings. To date, these initiatives have not shown definitive evidence of profitability and we believe
SAH will have continued difficulty implementing these strategies because of delays, stiff competition, and weak brand
power.
Cyclicality of Industry - SAH is vulnerable to an economic downturn due to the cyclical nature of automotive sales,
expense burdens from key initiatives, and their performance during the last recession. Based on historic trends in the
industry, a slowdown of automotive sales is likely in the near future. Since beginning development of EchoPark and
OSOE the industry has been recovering from a downturn in automotive sales caused by the Great Recession. Since then,
record high industry-wide sales have helped offset the negative near-term effects of SAH’s high capital expenditures.
We believe that when the next industry slowdown occurs, the reductions in automotive sales and large depreciation
charges will have a compounding impact that will cause a significant reduction in EPS.
Valuation - We believe SAH is a SELL with a target price of $18.19. This provides a -1.12% total price reduction from
the January 22, 2016 closing price of $18.40. Our target price was calculated using an equal weighting of discounted
5. Manheim Used Vehicle Value Index. (December, 2015). Retrieved from http://www.manheim.com/services/consulting#monthlyIndex
6. Morningstar, (2015). Ibbotson® SSBI® 2015 Classic Yearbook: Market Results for Stocks, Bonds, Bills, and Inflation 1926-2014. Chicago, IL: Morningstar, Inc.
7. Sonic Automotive, Inc. Form 10-K [PDF Document]. United States Securities and Exchange Commission. Retrieved from http://www.sec.gov/cgi-bin/browse-
8. Sonic Automotive, Inc. Form 10-Q [PDF Document]. United States Securities and Exchange Commission. Retrieved from http://www.sec.gov/cgi-bin/browse-
Retail Floorplan: a source of inventory financing used by retailers such as SAH, to purchase high cost inventory. The inventory purchased is used as collateral.
The financing costs associated with floorplans are factored into the price of the automobiles. Manufacturers often service the floorplans, but floorplans can vary
by issuer. Schedules can range from 5%-20% for each vehicle every 30-60 days. When each piece of inventory is sold by the dealer, the loan advance against the
inventory is repaid.
Seasonally Adjusted Annual Rate (SAAR): a rate that is adjusted to take into account fluctuations of values which occur due to seasonality. SAAR factors
make adjustments for seasonal changes in sales and annualize data, and thus is a better sales forecasting tool than simply observing month-to-month sales figures.
While the automobile industry is not a seasonal industry, there are strong seasonal trends for automotive companies. Sales are typically highest for automotive
retailers in October, and are about 30% higher than sales in January, which has historically been the slowest sales month. The SAAR is calculated by taking the
unadjusted sales rate for a specific month, dividing it by its seasonality factor, and then multiplying that result by twelve.
Manheim Used Vehicle Value Index: the Index is drawn from a database of over five million used vehicle transactions annually. Manheim developed a
measurement of used vehicle prices, which is independent of shifts in the specifications of vehicles being sold. Macro-Economic and industry factors contribute
to the overall stability of the used car market, but it can also be stated that more efficient remarketing strategies create minimal swings in vehicle pricing. The
Manheim Index is a good indication of pricing trends in the used vehicle market. In December, the overall value increased to 125.7, which is the highest level
since July 2011. On an annual basis, the Manheim Index rose 1.2% in 2015, 1.5% in 2014, and declined in 2013 and 2012 by 1.8% and 1.0% respectively.
Days Inventory Outstanding (DIO): a measure for the average number of days a vehicle sits in inventory.
New Vehicle Revenue Growth We believe new vehicle revenue will grow at annual rate of 0.50% to reflect our anticipation of a plateau or decline in automotive sales. We assumed this low average growth
rate because we expect a downturn in the forecast period but cannot predict the exact year. We expect disappointing growth due to the cyclical nature of automotive sales and
the impact of a decline in used vehicle pricing. A decline in used vehicle pricing will result in greater demand for used over new vehicles because of an increasingly large
affordability gap and less attraction for new vehicle leasing, effectively suppressing revenue growth. We believe SAH will suffer along with the rest of the industry.
Used Vehicles Revenue Growth We believe SAH’s used vehicle revenue will grow at a 7.2% five-year compound growth rate. We assumed a high level of growth to account for the impact of an increasing
affordability gap between new and used vehicles, and the potential success of EchoPark.
Wholesale Vehicles Revenue Growth We believe the revenue SAH gains from wholesale will decline because management has stated intentions to retail a larger percentage of vehicles.
Fixed Operations Revenue Growth We believe revenue from fixed operations will increase as demand will continue to stay strong. Consumers will still need to repair their cars and perform preventative
maintenance, regardless of whether they need to replace their current vehicle.
F&I Revenue Growth F&I revenue is driven by growth in total vehicle sales for originating a finance, insurance, or other aftermarket product. We believe F&I revenue will increase because we
forecast continued growth in total vehicle revenue.
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Appendix B: Financial Statements and Ratios (continued)
New and Used Vehicle Profit Margins In the past five years, SAH’s gross profit margins on both new and used vehicles have steadily declined. We believe this is primarily due to pricing pressure from the growing
amount of information available to consumers and the current lack of competitive advantage. We forecast new vehicle profit margins declining over the five years to 2020 and
used vehicle profit margins declining through 2018, with a slight increase in 2019 and 2020 after implementation of OSOE and firm establishment of EchoPark to account for
potential success.
Selling, General, & Administrative Expenses We believe SG&A will grow over the five years to 2020 to reflect higher expenditures from implementing OSOE and EchoPark.
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Appendix B: Financial Statements and Ratios (continued)
Appendix B: Financial Statements and Ratios (continued)
Balance Sheet Assumptions
Inventories We expect inventories will increase in the near future as suppliers produce more vehicles to accommodate current demand. However, we believe this represents a threat to
automotive retailers. Downturns in automotive sales are characterized by oversupply and low demand as retailers struggle to push cars off lots to consumers unwilling to replace
their current vehicle. The resulting impact on large dealership group financials is lower revenue and lowered profit margins, especially for new vehicles.
Property and Equipment Property and equipment is forecasted to grow as SAH rolls out their initiatives. Significant capital expenditures will be incurred for new openings of EchoPark stores and
renovations associated with OSOE.
Treasury Stock We assumed that in the current quarter there would be no more treasury stock repurchases given the $16.9M purchase completed in January. For each quarter after we predicted
SAH would maintain its average quarterly buy back from the past 5 years until the remaining $82.4M of repurchases have been completed.
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Appendix B: Financial Statements and Ratios (continued)
CRM (Customer Relationship Management: the OSOE depends greatly on the customer experience provided which is what OSOE was created on. The CRM implementation
is mainly a training tool to make sure new and current employees know what a customer wants and how to ensure they have an easy and relaxing experience buying a car
compared to a traditional dealership model.
Appraisal Tool: in conjunction with the CRM, an appraisal tool is used to assess the value of any trade-in vehicle that a customer would have when visiting the dealership. The
main difference between the OSOE appraisal tool and a traditional appraisal is transparency. According to Sonic, the new appraisal tool will break down each area of the car
and explain why the vehicle appraisal price is a fair price. This new assessment tool is designed along with the CRM to make the customer feel confident and trust in the car
buying experience that Sonic offers.
Desking Tool: the desking tool is an iPad that drives OSOE and is made to be both informative and reduce paper transactions thereby making the buying process take less time.
This brings what would normally be a 2-3 hour shopping excursion down to 1 hour or less. Electronic signatures are used to speed up the process.
F&I Tool: when a customer comes in looking to buy a car, Sonic needs to be able to provide adequate financing options. The F&I tool gives full transparency about the details
of the cost of the vehicle and any related F&I options.
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Appendix D: One Sonic-One Experience – Phased Rollout (continued)
Pricing Tool: to create trustworthiness and faith between the dealership and the customer, Sonic created a True Price® new car pricing model. This no haggle and transparent
pricing allows Sonic to offer a competitive price compared to their competitors. Management has stated that this pricing tool will differ from competitors because it uses 90-
day selling data to provide a real-time approximation of what price point at which SAH can effectively sell a car.
Inventory Management Tool: SAH has its own proprietary inventory management system that makes use of data analytics. Centralized inventory management system allows
for dealerships to benefit from all vehicles under the SAH brand, not just vehicles on their lots.
Compensation Tool: traditional dealerships base employee compensation on type and amount of vehicles sold while the OSOE compensates employees on a salaried basis.
Branding: sub-branding of all dealerships.
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Appendix E: Corporate Governance
O. Bruton Smith - Executive Chairman and Director
Age: 88
Founder of SAH
Appointed Executive Chairman and Director of SAH in July 2015
Served as Chief Executive Officer of Sonic Automotive, Inc. from January 1997 to July 2015
Chief Executive Officer, Executive Chairman, Director, and Controlling stockholder of Speedway Motorsports, Inc. (TRK), a publicly traded company on the New
York Stock Exchange
Experience in the automobile industry since 1966
Years with SAH: 18
B. Scott Smith – Chief Executive Officer, President, and Director
Age: 47
Co-Founder of SAH
Appointed Chief Executive Officer of SAH in July 2015
Served as Chief Strategic Officer of SAH from October 2002 to July 2015
President of SAH since March 2007
Vice Chairman from October 2002 to March 2007
President and Chief Operating Officer from April 1997 until October 2002
Director of SAH since January 1997
Son of O. Bruton Smith and the brother of David B. Smith
Over 20 years of experience in the automobile industry
Years with SAH: 18
David B. Smith – Vice Chairman and Director
Age: 40
Appointed Vice Chairman in March 2013
Executive Vice President and Director since October 2008
Senior Vice President of Corporate Development until October 2008
Vice President of Corporate Strategy from October 2005 to March 2007
Has served as Dealer Operator of several SAH dealerships prior to 2005
Son of O. Bruton Smith
Years with SAH: 17
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Appendix E: Corporate Governance (continued)
Heath R. Byrd – Executive Vice President and Chief Financial Officer
Age: 48
Chief Financial Officer since March 2013
Vice President and Chief Information Officer from November 2007 to March 2013
Director, President, Chief Operating Officer, Chief Financial Officer, and Chief Information Officer for HRAmerica, Inc.
Years with SAH: 8
Jeff Dyke – Executive Vice President of Operations
Age: 47
Vice President of Operations since October 2008
Division Chief Operating Officer - Southeast Division from March 2007 to October 2008
Division Vice President – Eastern Division from April 2006 to March 2007
Vice President of Retail Strategy from October 2005 to April 2006
Served positions in divisional, regional, and dealership management for AutoNation, Inc. from 1996 to 2005
Years with SAH: 10
Executive Team:
Position Total Compensation
O. Bruton Smith Executive Chairman, Director $3,791,078
B. Scott Smith Chief Executive Officer,
President, Director $3,298,560
David B. Smith Vice Chairman, Director $2,221,412
Heath R. Byrd Executive Vice President,
Chief Financial Officer $2,856,913
Jeff Dyke Executive Vice President,
Operations $3,683,224
Source: Company Website, www.morningstar.com
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Appendix F: Earnings History
Source: Bloomberg
Note: chart shows differences between management’s guidance and reported earnings for each quarter since 2008. In addition, reported EPS was -16.9 in Q4 2008.
-1
-0.8
-0.6
-0.4
-0.2
0
0.2
0.4
0.6
0.8
1
Q1
08
Q1
09
Q1
10
Q1
11
Q1
12
Q1
13
Q1
14
Q1
15
EPS History ($)
Reported Estimated
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Appendix G: Internet Presence
To be competitive in the automotive industry, a company must incorporate a strong online presence to effectively reach customers. Quality websites and efficient technological
platforms allow the customer to browse through inventory for multiple dealership locations. We believe SAH’s website provides the basic capabilities of shopping for vehicles,
but lacks sound functionality and user friendliness compared to its competitors. AN, KMX, and ABG are examples of automotive retailers that provide more effective websites
than SAH. While it is our belief that SAH’s main company website lacks what their competitors have already achieved, the EchoPark website provides a much easier and more
In comparison to SAH (center), AN’s (far left) and KMX’s (far right) websites are shown above. Aesthetically, AN and KMX are more appealing and offer a wider variety of
navigational options through both their home pages, services, vehicle information, as well as a company overview. While SAH does incorporate navigational tools to move
throughout their website, we believe AN and KMX take further steps to create a more effective layout. Time is essential when shopping for vehicles on the internet, and if an
automotive retailer can cut the steps it takes to get to a destination on the web, reaching the customer becomes simpler.
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Appendix G: Internet Presence (continued)
Website Presence & Effectiveness
SAH AN KMX
Site Visits 35,000 230,000 3,000,000
Time on Site 2 minutes, 12 seconds 5 minutes, 30 seconds 7 minutes, 55 seconds
Bounce Rate* 40.56% 33.32% 16.43%
Source: www.similarweb.com
*A bounce rate is the percentage of website visitors for a particular website who navigate away from the website after viewing only one page.
Note: dollar amounts are in thousands, except per share data.
WACC Analysis
Cost of Debt 1.3% 64.2% wt.
Cost of Equity 14.9% 35.8% wt.
WACC 6.18%
Year Free Cash Flow Value Dec. 31,
2016
2017 44,693 43,373
2018 67,987 62,138
2019 71,678 61,697
2020 87,082 70,593
DCF Target Price Calculation
Sum of Dec. 31, 2016 Values 237,800
Terminal Value 2,285674
Net Debt (1,641,737)
Equity Value 881,737
Estimated Shares Outstanding 49,811
Target Price $17.70
Source: Team Calculations
Source: Team Calculations Source: Team Calculations
2016 CFA Institute Research Challenge SAH
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Appendix J: Valuation Summary (continued)
P/E Multiple Summary
Historic P/E Industry AN KMX SAH
TTM 10.48 11.52 15.24 9.28
5yr Average 14.85 16.91 20.51 10.45
10yr Average 14.07 17.51 22.89 10.02
Maximum (10yr) 53.59 39.85 61.94 23.84
Minimum (10yr) 6.76 8.05 8.05 2.13
Estimated 9.00
Source: Bloomberg and Team Calculations
SAH’s P/E has trailed the industry by 30% and it has not been higher than
the industry average since before 2000. SAH’s P/E moves cyclically and is
coming off of a recent high so it will likely continue to trend lower. We believe
that a contributing factor to SAH lagging the industry in stock
performance is the negative impact of corporate governance due to the
Smith family having complete voting control. We believe this devalues all
other voting shares. Taking all of this into account, we reached our target
P/E of 9.00.
Note: gap from 1/09 – 1/10 represents negative EPS.
P/E Target Price
2016 EPS Estimate 2.08
Estimated P/E 9.00
2016 Target Price 18.68 Source: Team Calculations
P/E since 2000
Source: Bloomberg
0
10
20
30
40
50
60
SAH Competitor Average
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Appendix K: Sensitivity Analysis
This chart displays a set of results for a uniform change in both revenue growth and gross profit margin assumptions at a range of P/E multiples.
P/E -1.0% -0.5% Base +0.5% +1.0% +1.5% 2.0%
8.00 14.17 15.38 16.61 17.85 19.10 20.36 21.63
8.25 14.61 15.86 17.13 18.41 19.70 21.00 22.31
8.50 15.05 16.34 17.65 18.91 20.29 21.64 22.98
8.75 15.50 16.82 18.17 19.52 20.89 22.27 23.66
9.00 15.94 17.30 18.68 20.08 21.49 22.91 24.33
9.25 16.38 17.78 19.20 20.64 22.08 23.55 25.01
9.50 16.82 18.26 19.72 21.20 22.68 24.18 25.69
9.75 17.27 18.75 20.24 21.76 23.28 24.82 26.36
10.00 17.71 19.23 20.76 22.31 23.88 25.46 27.04
10.25 18.15 19.71 21.28 22.87 24.47 26.09 27.71
10.50 18.60 20.19 21.80 23.43 25.07 26.73 28.39
Source: Team Calculations
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Appendix K: Sensitivity Analysis (continued)
This chart displays a set of results for a uniform change in both revenue growth and gross profit margin assumptions at a range of terminal growth possibilities.