It’s perhaps the most hated bull market in America that seemingly defies all expectations (and desires to be honest). Following the severe disruption of the novel coronavirus pandemic, several markets went haywire to the upside, including most conspicuously the used-car sector. But with media reports stating that wholesale prices for secondhand vehicles have been moving lower from their highs, this boded poorly for auto stocks.
Until, that is, the situation started boding positively again for auto stocks. What gives? Another false-positive? In this particular case, seemingly contrasting events are actually both true. As CNN pointed out, lower wholesale prices may not translate to lower consumer costs because dealerships these days rely less on wholesale and more on directly acquiring inventory from private sellers.
More critically, the semiconductor crisis that has resulted in an ongoing computer chip shortage that frustratingly ebbs and flows has contributed to production shortages. In a rather surprising article by Bloomberg, journalists Ian King and Debby Wu chastised the Biden administration, declaring in August of this year that the automakers’ chip crisis isn’t getting better. Indeed, semiconductor firms disclosed that tight supplies will last into 2022, which cynically supports the case of auto stocks — crimped inventory should boost demand.
It gets worse. In the second half of August, Toyota (NYSE:TM) sent shockwaves throughout the industry when it revealed that it must cut global production by 40% in September. This action mirrors that of the car manufacturing giant’s rivals, which are reallocating whatever chips they have toward their highest-profitability vehicles. In turn, several vehicle categories will suffer shortages, which helps auto stocks specializing in secondhand sales.
Unfortunately, nobody has a clear view of how this semiconductor crisis will end. Automakers are putting up a brave front not to scare off their stakeholders, which is understandable. But then, we’re left in a cloud of ambiguity that will only serve to frustrate consumers. One thing appears clear, though: auto stocks may still have more legs remaining despite their bubbly valuations.
Theoretically, it’s possible that in a few weeks, we could get news from chip manufacturers that they’re back on the production swing. However, bear in mind that the cars won’t magically reappear on dealer lots the next day. It’s going to be a while for the industry to work through the backlog, which may mean that these auto stocks could be relevant for at least the entirety of 2022.
- CarMax (NYSE:KMX)
- AutoNation (NYSE:AN)
- Lithia Motors (NYSE:LAD)
- Carvana (NYSE:CVNA)
- Carparts.com (NASDAQ:PRTS)
- O’Reilly Automotive (NASDAQ:ORLY)
- Advance Auto Parts (NYSE:AAP)
Auto Stocks to Buy: CarMax (KMX)
On paper, CarMax just seems due for a correction. As KMX shares started moving higher, I backed off talking about it too much out of concerns that the intense wave of consumer interest for used cars will fade. Don’t get me wrong, I love the company’s business model, particularly its extended warranty program — a must if you buy European (or American) cars. But it just seemed a bit too rich.
On a year-to-date basis, KMX stock is up nearly 41%. Yet over the trailing five days since Sep. 8, KMX gained nearly 5%, which suggests that some of the news regarding computer chip shortages are filtering their way into the valuations of auto stocks. Because of the dramatic disclosures about production cuts among major automakers, I’m going to have to change my tune: CarMax might still be a buy, even at these levels.
If you’ve been watching YouTube gurus, many self-proclaimed auto industry experts have been warning consumers to avoid the ramped-up prices earlier this year. However, the chip shortage implies that people may have to wait a year-and-a-half possibly to acquire used cars at a reasonable price.
Unfortunately, millions of car buyers can’t wait that long. Thus, KMX may be a necessary evil among auto stocks.
An automotive retailer that operates with a similar business model to CarMax, AutoNation has also benefitted from the ridiculous bull market in auto stocks. Ordinarily, I wouldn’t be that excited about a company that’s very similar to another industry leader.
From my experience, AutoNation doesn’t pay out nearly as much for your used car like CarMax does. On the plus end, though, I find AutoNation’s prices on their vehicles to be much fairer than CarMax’s on average, with both companies deploying a no-haggle pricing model.
But the overriding point is that the low-inventory situation that caused the initial surge in used vehicle prices may be here to stay, at least for the next year. As evidence, consider CBS News’ San Francisco affiliate, which reported that shoppers for the traditional Labor Day weekend auto sales festivities found slim pickings this year.
Moreover, AutoNation’s days inventory confirms that this isn’t a localized incident. Featuring about 44 days inventory over the trailing-12-month (TTM) period, this metric is well off the approximately 70 days of inventory seen during 2016 through 2019. Other retail auto stocks are experiencing the same pressure, which is positive for AutoNation’s profitability performance.
Auto Stocks to Buy: Lithia Motors (LAD)
Another nationwide automotive retailer, Lithia Motors is the third largest such company in the U.S. Though not nearly as much discussed as CarMax and AutoNation, the ongoing computer chip crisis is almost a perfect calamity for LAD stock. After posting solid growth in the few years leading up to the pandemic, Lithia Motors is poised for serious gains in its financials.
For instance, for the company’s second-quarter earnings report, it generated revenue of $6 billion, up 118% from the $2.76 billion it rang up in the year-ago quarter. As well, net income ballooned to $305 million in second-quarter 2021, almost 4X higher than what Lithia posted in Q2 2020.
Again, the catalyst is a familiar one among auto stocks — lack of inventory. From 2016 through 2020, Lithia’s days inventory (on an annual basis) never slipped below 80 days. But on a TTM basis, the company saw its days inventory slip to 54.3. In Q2 of this year, the metric was 42.6.
Granted, having an artificially low inventory situation isn’t the most efficient means of generating top-line sales. But the dynamic with auto stocks is that people need to get from point A to point B. This universal need may lift LAD higher.
Perhaps no other company among auto stocks epitomizes the generational split between millennials and other demographics than Carvana. In the analog age, barking at the auto salesperson and going through the “gotta-talk-to-my-manager” routine represented a rite of passage.
Today, a majority of millennials (56%) surveyed by online car marketplace Beepi stated that they preferred cleaning their homes rather than dealing with a car salesperson. Since vacuum cleaners don’t talk back, I can understand why this might be more preferable. Carvana went a step further, delivering an online automotive marketplace so that millennials — and other folks — don’t have to hardly deal with anyone.
During the Covid-19 crisis, of course, CVNA became one of the top auto stocks because the underlying company was practicing social distancing before that term became a thing. But with arguably most folks acclimating to the public health crisis, does Carvana still have gas in the tank?
In short, yes. In Q2 of this year, Carvana posted a positive net income — the first time it did so since Q4 2017. That was thanks to overwhelming demand, demand that might not fade for a while based on the aforementioned circumstances.
Auto Stocks to Buy: Carparts.com (PRTS)
Back when the novel coronavirus initially capsized us, Carparts.com enjoyed a powerful if not cynical catalyst. With so many businesses shut down and with deepening concerns at the time of the infectiousness of the SARS-CoV-2 virus, very few people wanted to interact with strangers. But what to do about routine car maintenance?
For that, Carparts.com filled a critical void, allowing folks who were good with their hands to take care of their own vehicles. And while there are plenty of jokes about millennials being useless with functions that don’t involve a keyboard or touchpad, several million car owners grew up in a culture that required them to know the basics.
Moving forward, it’s very possible that Carparts.com may enjoy a longer-than-expected upside pathway similar to retailer auto stocks. Primarily, those folks who have been caught blindsided by rising prices may elect to hold onto their vehicles a year or two longer. If so, demand for automotive parts will increase, which should benefit PRTS stock.
In fact, Carparts.com CEO Lev Peker told Fox Business that “Everything is back ordered” due to “a very tight supply chain right now.”
O’Reilly Automotive (ORLY)
A car parts retailer and the originator of one of the most memorable jingles — “O-o-o, O’Reilly… (O’Reilly!) Auto Parts” — O’Reilly Automotive has been a massive beneficiary of the Covid-19 crisis. Usually, a company like this is fairly slow moving, but on a YTD basis, ORLY gained over 30%. Since its March 2020 doldrums, shares have more than doubled.
A main advantage that O’Reilly has over online-based auto stocks is that the company has physical locations throughout the country. Sometimes, you just don’t know what you need until you see the products in question. As well, O’Reilly offers free store services, including battery/alternator/starter testing, along with diagnosing what that pesky check engine light means. You can’t do that online.
Further, for the do-it-yourself community, the company provides fluid and battery recycling services. As you might guess, dumping such fluids in inappropriate places is a big no-no. Plus, I’d like to think that more folks are aware of recent environmental issues with what we’ve endured over the past year-and-a-half. Thus, you might say that O’Reilly has some environmental, social and governance (ESG) credibility.
Auto Stocks to Buy: Advance Auto Parts (AAP)
Rounding off this list of auto stocks is Advance Auto Parts, a retailer specializing in aftermarket parts. Although most of the attention during this bubble has been directed toward used car dealerships, we shouldn’t forget the impact that Covid-19 had on the automotive parts industry. According to an Associated Press report:
“The global parts shortage involves not just computer chips. Automakers are starting to see shortages of wiring harnesses, plastics, and glass, too. And beyond autos, vital components for goods ranging from farm equipment and industrial machinery to sportswear and kitchen accessories are also bottled up at ports around the world as demand outpaces supply in the face of a resurgent virus.”
In other words, don’t just think that if you’re not in the market for a vehicle, you’re not going to be impacted by the automotive parts shortage. Should your car need something, there’s a good chance the supply chain for that component has been affected, which could affect pricing.
Of course, that’s tough on the consumer but if you’re a stakeholder in AAP stock, this pandemic might well be a “blessing” in disguise.
On the date of publication, Josh Enomoto did not have (either directly or indirectly) any positions in the securities mentioned in this article. The opinions expressed in this article are those of the writer, subject to the InvestorPlace.com Publishing Guidelines.
A former senior business analyst for Sony Electronics, Josh Enomoto has helped broker major contracts with Fortune Global 500 companies. Over the past several years, he has delivered unique, critical insights for the investment markets, as well as various other industries including legal, construction management, and healthcare.