Sunday, June 29, 2008

Asbury Automotive On Dangerous Ground

At first glance, Asbury Automotive (ABG) looks like it could be a value play. It trades at a discount to its book value, has a P/E of 7, and pays a dividend of almost 7%!

Asbury also does not have it's own financing arm, and is therefore relatively shielded from the current situation in credit markets. Its presence in the luxury car segment should also help protect it to some extent from the current downturn, and its largest profits come from vehicle repairs, which consumers require no matter what the state of the economy.

So what's wrong with this company...isn't it a clear buy? Well there are a few areas of concern.

To me, their problems stem from their debt levels. Their operating income is only 2 times interest expense for one thing, yet they payout roughly half their net income in dividends. If things were to turn south, they have very little protection to be able to make these payments.

It looks like debt holders have recognized this, and are wary. They have placed covenants such that Asbury has a ceiling on what it's allowed to pay shareholders (in share purchases or dividends), and this ceiling only grows at 50% of net income (as it's accrued), minus payouts. At the present time, that ceiling stands at just $13.2 million, which is just about 40 cents a share! Imagine a company so restricted, it's not allowed to pay it's owners even half of the cash it has on hand!

Nevertheless, the company continues to pursue acquisitions, which seems a little strange, considering their return on assets (less than 5%) and return on equity (less than 10%) are nothing to write home about, despite leveraging to the hilt! And they don't seem intent on paying off their debt, as they continue to make sale-leasebacks, where they sell off their properties, but now have to pay rent on them!

As long as the company makes its sales numbers, it will be fine. But any unexpected hitch, however small, can cause great damage to the small portion of equity that is left after debt obligations are satisfied, making this company not worth the risk.

Disclosure: None

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