Sonic Automotive Is On The Move Ahead Of Earnings

An Earnings Story With So Much More

With earnings season in full swing, it’s no surprise to find stocks on the move. Usually, you find stocks moving after the release, less often before the release, but in either case, it can be an indication of future investment results. In this case, Sonic Automotive (SAH) is moving higher before the release and the why is very important. Sonic Automotive is a dividend-growth stock with expansion in progress and a distribution increase on tap.

Expansion Is In Progress

At first glance, you might think Sonic’s share price is rising because the company is expected to post solid earnings growth and that is true. Sonic has been executing on a two-pronged strategy that has been driving results in all three segments of business; franchised new-car sales, used cars and certified pre-owned.

The gem of the strategy is Echo Park. Echo Park is a certified pre-owned auto dealership and it is growing fast. Over the first three quarters of the year, the Echo Park franchise exceeded management’s own wildest expectation. Each quarter, management increased its forecast for the next and that is expected again this quarter.

The company has only 9 locations in operation now but is expected to open at least four more by the end of the calendar year. If results are typical, the new stores could drive a 44.5% increase in segment revenue not counting the impact of comp-store growth. That 44.5% is equal to 5% of total revenue.

The Used Car Market Is Hot

While sales of new cars continue to stagnate there is a robust outlook for used and pre-owned car sales in 2020. Sales of used and pre-owned cars rose mid-single digits in 2019 and are expected to accelerate in 2020.

The only negative in the outlook is that prices are expected to moderate as more inventory comes on the market. Because the margins for used cars are far greater than for new cars, about $950 per car versus $140, declining prices are not a major worry provided demand improves as expected.

Jessica Caldwell, Edmunds executive director of industry analysis, said this in a recent market analysis …

“Used vehicles will likely grow in popularity as new-car substitutes if incentives continue to stagnate and interest rates creep up. A large quantity of near-new used vehicles are expected to come into the market that will undoubtedly offer a compelling value message that resonates with discerning new-car shoppers.”

A Dividend Increase Is Expected

After digging a little deeper you will find Sonic is a dividend payer and a dividend grower. Better yet, it is expected to deliver another distribution increase this earnings cycle and it could be a big one. The company has been incrementally increasing the dividend since the 2008 Financial Crisis (when they had to cut it) and has stepped up those efforts over the last two years.

Sonic Automotive increased its distribution regularly for the last two years and by substantial margins. The company still has a very low payout ratio, near 16%, which means the company could double the payout and not hurt its cash-flow situation.

Sonic has very little in the way of debt but it is funding the Echo Park expansion internally, so I don’t expect the increase to be quite that large. Even so, the five-year CAGR of the distribution is 32% suggests a solid double-digit increase. The downside is the yield is low, about 1.20%, and easy to beat with other investments. The upshot is capital appreciation and total returns could easily reach the 20% to 30% range over the next 12 months.

The Technical Outlook Is Bullish

Shares of Sonic Automotive have been ratcheting higher since the first quarter of 2019. This move coincides with the proof-of-concept of Echo Park’s first locations and the ramp of its expansion. The stock recently broke to a 13-year high and is now in consolidation above a key support target. Price action just confirmed support at the short-term moving average and the previous high pointing to a continuation of the rally.

The indicators are bullish and convergent with the move higher. This combiation points to a retest of the recent highs at least and the possibility of retesting the all-time highs. A move up to the $35 level, inclusive of dividends, would be a +10% gain over the next 12 months. A move up to the all-time high at $40 would be a gain of 20%.