Thursday, July 24, 2008

Auto Retailers Ranked by Abilty to Pay Debt

It's no secret that for various reasons, Americans have recently cut back on their spending. Since cars are big-ticket items, this drop in spending has manifested itself with utmost clarity in the auto retail space. US motor vehicle sales were down some 18% in June year over year. As a result, many car retailers have been punished in the market.

Could this create a buying opportunity? Often, cyclical downturns allow long-term investors to pick up decent companies at bargain prices. In the case of auto retailers, when the economy returns to normal, people may not buy trucks and SUVs at the same pace as they had a couple of years ago, but we can nevertheless expect vehicle sales to recover from their current lows. Unfortunately, it's difficult to determine just how long a downturn will last.

Because downturns of unpredictable magnitude occur every few years, value investors tend to prefer buying companies with low debt levels, since these are the most likely to be able to last through a recession and re-emerge from it in strong positions as compared to the competition. Therefore, in these uncertain times, when examining the depressed auto retailing sector, it may be wise to consider which companies must focus on making ends meet just to make their next debt payments, and on the other side, which companies can afford to take advantage of the situation to position themselves for future growth. With that in mind, here are some major US auto retailers ranked by their interest coverage ratios:

From the chart, it appears that both CarMax and America's Car-Mart are positioned to outlast their competitors should this be a prolonged downturn. They may even choose to make further investments without risking the viabilities of their companies and thus emerge in better positions than the rest of the group.

At the bottom of the list we have Lithia, who swung to a loss last quarter simply due to their interest payments. Management of this company can hardly focus on the long-term health of the company when they are busy trying to find ways to make the next several interest payments.

Most of the companies lie somewhere in between, though their interest coverages are somewhat on the low side. As we've discussed here, Asbury is an example of a company that doesn't have a lot of leeway when it comes to making the payments it has committed to.

Of course, this is only an initial, cursory look at these companies. One still has to dig into the financial statements to make a full and proper assessment, as discussed here. For example, there may have been special items last quarter that caused operating income to be higher or lower than it would otherwise normally be, and this would skew the interest coverage ratio. Nevertheless, this is a good starting point to determine which stocks look safe enough to last through a downturn of unknown magnitude.

Disclosure: None

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