AutoNation Gets It In Gear

The stock rises after a second-quarter upside surprise.
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AutoNation

(AN) - Get Report

has shifted out of reverse.

After backsliding in recent quarters, the nation's largest auto dealer zoomed past Wall Street expectations Thursday by delivering the most profitable second quarter in company history. The giant auto chain easily topped its own guidance, lowered in April to between 29 cents and 31 cents a share, with second-quarter profits of 37 cents. So Wall Street, which had been looking for 30 cents on average, enjoyed an upside surprise from a company already known for handily beating expectations.

Even a former AutoNation critic, who bet against the stock earlier this year, said he was impressed.

"The used car market is bouncing off the bottom, which is helping, and the company continues to do well on costs," the hedge fund manager said. "The results look strong."

Encouraged by the turnaround, AutoNation hiked its full-year guidance -- lowered just three months ago -- by 7 cents to between $1.28 and $1.33 a share. The company also offered third-quarter guidance of up to 36 cents a share, which would beat current estimates by 2 cents.

AutoNation CEO Mike Jackson did offer some words of caution, however.

"While we are hopeful that efforts to stimulate the economy will take hold," he said, "we believe that the auto retail environment will remain challenging for the remainder of the year.

Still, AutoNation has already shown dramatic improvement from a weak first quarter that brought declines in nearly every major category. The company was able to report a slight jump in revenue -- up 1% to $5.07 billion -- and a 2% increase in net income to $106 million.

But aggressive cost-cutting and share repurchases -- a strategy questioned by some -- really drove EPS growth. By trimming expenses another full percentage point, the company managed to report its third-straight quarter of margin improvement. And stock buybacks totaling $149 million reduced outstanding shares by 4%.

Since the first quarter of 2002, AutoNation has repurchased 20% of its own stock. And the company plans to continue its aggressive buying despite a 35% surge in its share price this year.

"We still feel our stock is undervalued ... and we will continue to acquire it," Jackson told analysts, when questioned during Thursday's conference call about possibly paying a dividend instead.

Agreeing to Disagree

Bear Stearns analyst Domenic Martilotti, who cut AutoNation from outperform to perform two weeks ago, clearly doesn't share the company's view. Martilotti lowered his rating on the stock because he saw it as overvalued after it passed $16. (It has since climbed even higher, tacking on 38 cents to hit $17.25 Thursday.) And he suggested that the company consider a dividend to attract new investors looking to benefit from favorable tax changes.

"This would open up a new investor base of income investors," he explained, "where AutoNation's shares and its peers are limited to growth investors."

But AutoNation described itself Thursday as "still a young company" that's currently better off investing in itself than committing to a permanent dividend. Company insiders haven't been throwing their own money at the stock, however. During the latest period, director Harris Hudson announced plans to sell 500,000 shares -- valued at $7 million -- and fellow director Irene Rosenfeld netted $165,000 by executing an options transaction for 22,157 shares. ESL Investments, which owns more than 10% of AutoNation, also disposed of 2.94 million shares in a non-open-market transaction.

Earlier this year, company insiders -- including outgoing Chairman Wayne Huizenga -- came under fire for executing big stock sales just ahead of a regulatory filing that contained what some viewed as a profit warning. The board, including recent stock-seller Hudson, also has been criticized for its alleged lack of independence.

AutoNation has since pledged to build a stronger governing body, adding two new independent directors in the latest quarter. Although half of AutoNation's veteran directors have enjoyed lucrative side deals with the company, Jackson declared Thursday that the newly constituted board could breeze past stiffer requirements.

"We believe a substantial majority of the board will qualify as independent," he said.

In the meantime, Jackson pointed to AutoNation's rank and file as a sign of company strength.

"We are really proud of our associates," he concluded in a discussion before analysts. "The payoff is an outstanding performance in a difficult market."