After a look under the hood, some investors are starting to question

AutoNation's

(AN) - Get Report

sticker price.

The country's largest automobile retailer has always commanded a generous premium over its smaller peers. The reasons for this are threefold: AutoNation is generally less leveraged than most other auto sellers. Having already gobbled up hundreds of dealerships, it's no longer dependent on acquisitions for growth. And it's just plain big, offering the liquidity and, beginning this year, the

Standard & Poor's

listing that some institutions demand.

Raymond James analyst Gerald Marks, who likes the entire sector, says AutoNation will probably always trade at a premium because of these factors alone.

But some industry veterans aren't buying this sales pitch. They've taken a hard test drive through AutoNation's regulatory filings, and they're ready to toss the keys. They see low-quality earnings -- and feel a miss coming on this quarter. They've spotted performance problems that no simple tune-up may be able to repair. And they're convinced that the company's own stock repurchases -- representing large chunks of the daily trading volume -- are what's responsible for keeping the stock afloat during a severe market downturn. That can't go on forever, they point out. (They also note

insider selling and related-party dealings at AutoNation.)

In short, they question AutoNation's fundamentals and believe the company could be running out of gas.

"There's really no reason for AutoNation's

price-to-earnings ratio to be so different from everybody else's," said one hedge fund manager. "One could even argue that they don't deserve a premium at all."

Questioned about specific concerns on Friday, the company said it didn't have time to present its argument before today's story.

Fuel Injection

On the surface, AutoNation appears to be humming right along.

The Fort Lauderdale, Fla.-based auto chain recently zoomed past analysts' expectations, delivering the biggest fourth-quarter upside surprise of any player in its group. The market has rewarded the company, whose shares closed Friday at $12.78, with a P/E that's at least 45% above the other players in its group.

But critics feel something shaky in the company's 2002 performance. They point, in particular, to three troubling ingredients that helped boost the company's profits.

First, AutoNation collected $13.9 million in underwriting income -- from a loan operation it discontinued a year earlier -- that flowed into operating earnings. Second, critics say, the company generated $5.9 million in fourth-quarter income from a land sale program that actually cost it $3.3 million the previous year, helping with year-over-year comparisons. And finally, the company slashed its reserves for doubtful accounts from $43 million to $22.5 million -- leaving reserves at their lowest level in three years.

"The difference between what they should have done

with the reserves and what they have done is about 10 cents a share," one short-seller said.

Taken individually, these sums may seem insignificant for a company that last year raked in $380 million worth of profits. But together, they formed a nice cushion that helped AutoNation bounce past Wall Street targets.

Today, even some AutoNation bulls -- who applauded the company's fourth-quarter surprise as encouraging -- doubt the company's roll can continue. Marks, for example, has established a 2003 earnings target of $1.22 a share. That's 3 cents shy of the company's lowest guidance.

"While attainable, we think the company has established an aggressive target," explained Marks, who nevertheless has an outperform rating on the stock.

Bearish investors, including some who have shorted more than 9% of the company's stock, are looking for an earnings miss this very quarter. In the meantime, they've compiled a laundry list of reasons why AutoNation looks a bit like a lemon when compared to its less expensive peers.

Breakdown

In firming up their stance, the bears recently took a spin through AutoNation's "strong" fourth-quarter results. Here's what they found.

AutoNation lagged behind its peers in several major categories. The company posted the sector's biggest slowdowns in overall sales growth, same-store sales and comparable new vehicle sales. It ranked in the bottom half of its six-member peer group on comparable service and parts sales. And it barely made the top half in comparable used vehicle sales, which still slumped 12% from the year-ago period.

Granted, large companies often compare unfavorably with smaller players still going through their growth spurts. But bears see more to dislike.

They point, for example, to AutoNation's product mix. The company depends on the Big Three domestic brands for roughly 60% of its sales, making it stand out among publicly traded peers weighted more heavily toward foreign brands that boast higher valuations and stronger growth prospects.

"Right now, it's more favorable to be with a foreign mix," Marks admitted. "That's probably not a bad course of action to be taking."

Bears also question AutoNation's true debt load. They point out that the company must pay out $470 million in deferred taxes over the next several years. They are therefore counting this money as debt -- since it's money clearly owed -- when calculating AutoNation's enterprise value, or what the market believes the company's ongoing operations are worth. (Enterprise value is equal to a company's market capitalization, plus its debt, plus any preferred stock, minus cash and cash equivalents.) That extra debt would inflate AutoNation's enterprise value by $1.60 per share. As a result, AutoNation's enterprise value-to-sales ratio would jump from 23% to 25% -- compared to a peer average of only 15%, which makes AutoNation look even more overvalued than it may already be.

Simply eliminating the company's P/E premium to its rivals could strip $5 from the stock, the bears contend.

Stock Cars?

In the end, short-sellers see a couple of outside reasons -- unrelated to company fundamentals -- that help explain AutoNation's stock price. One is the company's recent addition to the S&P 500 index. And the second is a stock-buyback program that, they believe, has kept AutoNation shares afloat only at the cost of a potentially imprudent use of company funds.

During 2002, AutoNation spent $390 million purchasing 30.7 million of its own shares -- picking up, on average, 123,000 shares per trading session. But just ahead of its recent addition to the S&P 500, the company stepped up its buying. In the first 38 sessions of 2003, AutoNation paid $109 million to snatch up an average of 232,000 company shares daily -- more than one-quarter of the total shares traded in a typical session before the company's jump into the S&P.

By paying nearly 10 times the company's EPS, critics say, AutoNation didn't necessarily get a bargain on that stock either.

"Mathematically, it is a truism that a company that buys back its stock at 5.8 times EPS

the peer average has much more accretion than a company trading at 9.9 times," which is AutoNation's multiple, one fund manager said. "This will give AutoNation a lower EPS growth rate relative to its peers."

In conclusion, that critic views the rewards from AutoNation's buyback program as limited, and temporary at best.

"The buybacks," he said simply, "have artificially inflated the stock price."