AutoNation and the US Automotive Industry - Example

AutoNation and the US Automotive Industry and of the Table Contents 1 1.0 Introduction 3 2.0 The Profitability and Risk 3 2.1 The Profitability 4 2.2 Risk 12 3.0 The Financial Projections of AutoNation 16 The cash flow from operations is expected to increase consistently in the next five years; however, the cash flow from operations would increase at a decreasing rate. The cash flow is expected to increase by 15% in the first year; the rate would increase by 14% in the second year; in the 3rd, 4th and 5th year, the rate would increase by 13%, 12% and 11% respectively. It is expected that the profits from the company’s activities would increase at a decreasing rate due to stiff competition of existing and new firms in the industry. On the other hand, the capital expenditure would grow consistently in a period of five years; however, the capital expenditure would also grow at a decreasing rate. The capital expenditure would grow by 15%, 14% and 13% in the 1st, 2nd and 3rd year respectively. The 4th and 5th year would witness an increase of 12% and 11% respectively. While the cash flow from operation grows at a decreasing rate, it is expected that the capital expenditure would replicate the same trend 18 4.0 The Value of a Firm 18 5.0 Conclusion 20 Works Cited 21 Appendices 22 1.0 Introduction AutoNation is currently the largest automotive company in the US; it is also popular among customers as the top firm as far as the selling of new and used vehicles is concerned (Morningstar 1). The company began its operation in 1996 under the name Maroon; in 2013, the company changed the previous name (Maroone) to the present name- AutoNation (AutoNation 1). The company has more than 250 dealerships which are situated in different US’ states; through the dealerships, the company sells more than 30 different brands of new vehicles (Morningstar 1). The management of the company comprises of the Chief Executive Officer, Mike Jackson and Mike Maroone, who is currently the Chief Operations officer. Maroone is also the president of the company while Mike Jackson operates as the chairman (AutoNation 1). Presently, the company is headquartered in Fort Lauderdale in the Florida state (AutoNation 1). With respect to the financial performance, the company managed to earn significant revenue of $17.517 billion as of 2013 (Morningstar 1). The total assets and equity were recorded at $7.914 and $2.061 billion respectively at the end of the accounting period (December 2013) (Morningstar 1). With respect to the background provided regarding the AutoNation’s information, this report is aimed at examining the profitability and risk that AutoNation is facing. The report will later assess the AutoNation’s financial projections, as well as asses the value of the firm. 2.0 The Profitability and Risk The assessment of a firm’s profitability and risk is imperative as far as the sustainability and success is concerned. The measurement of the profitability is important since it determines the level of return a business is experiencing, as well as forecasting the future performance; it also provides the management an avenue for judging and making various decisions as regards the future returns. The profitability is not only important to the management but also investors; investors are normally interested in the past performance of accompany with respect to profitability; the past performance typically provides a platform for predicting the future performance; it is on the basis of the past and predictable future performance that investors make decisions regarding an investment. Similarly, the risk of a firm is considered to be crucial in determining the future performance; the ownership of a firm normally assesses the risks that a company is facing in order to offer solutions at an early stage. There are various ways of determining the risk of a business including the determination of the working capital (Berman and Knight 11). 2.1 The Profitability Table 1 Profitability: Growth Year 2011 2012 2013 The Profitability Net Margin% 2.03 2.02 2.14 Assets Turn Over 2.27 2.34 2.32 Return on Equity% 14.16 17.66 19.99 Return on Invested Capital% 6.15 6.42 7.46 Return on Assets% 4.62 4.72 4.96 Source: Morningstar, AutoNation, Jun. 2014, Web. Assets Turn Over The Assets Turn Over is a financial ratio that is used to indicate the level of revenue for every dollar of an asset. A firm that has high revenue in relation to the amount of assets is mostly chosen as an investment opportunity among investors; the Assets Turn Over is calculated as ratio of sales to total assets. The average of assets turnover increased in 2011 and 2012; the financial ratio was reported 2.27 and 2.34. However, the assets turnover declined in 2013; it was established at 2.32. The average assets turnover was maintained above 2.20%; however, it did not exceed 2.35%. The future average turnover is expected to be maintained at between 2.2% and 2.4% (AutoNation 1). Table 2 Source: Morningstar, AutoNation, Jun. 2014, Web. Return on Capital Employed A Return on Capital Employed is one of the financial ratios that are considered crucial in assessing the profitability, as well as the efficiency of a firm; generally, investors are usually in need of understanding the effectiveness of the capital employed in a business to generate profits. The Return on Capital employed is ratio of the net income before tax and interest to the capital employed; the capital employed of a firm is the sum of the shareholders equity and long term debt. It can also be computed by subtracting the short term liabilities from the total assets; a firm that has a high return on capital employed is perceived by investors as the most effective in as far as ensuring the investment of a firm experiences a reasonable return in relation to other investments on a given market. The AutoNation’s Return on Capital Employed improved consistently in a period of three years. The financial statements provided by Morningstar show that the return on capital employed improved from 6.15% in 2011 to 6.42% in 2012; the return 7.46% (1). This indicates that the company’s investment, which is contributed by equity and long-term debt, are effective in generating a high level of level of return. Table 3 Source: Morningstar, AutoNation, Jun. 2014, Web. The Return on Equity The Return on Equity is among the financial ratios that are popular the stock investors, as well as other types of investors; the return of equity is measures as ratio of the net income to the shareholders equity. It normally measures the return of a dollar that an investor has invested in a company; generally, investors are normally attracted to company that are associated with a high level of return. AutoNation’s Return on Equity increased consistently in a period of three years. As of December, the return on equity was measured at 14.6%; the Return on Equity increased to 17.66% and 19.99% (AutoNation 1). This indicates that the company is ensuring that the shareholders are experiencing a high return for their investment. The trend is likely to be witnessed in the future; as a result, a large number of investors are likely to retain their investment; on the other hand, new investors are likely to invest in AutoNation due to a high rate return on equity. Table 4 Source: Morningstar, AutoNation, Jun. 2014, Web. Net Margin The net margin is one of the ratios that are used to assess the profitability of a business; in order to the net margin, the net profit is normally divided by revenue. It typically shows the ability of a firm to convert every dollar earned from sales to a profit; in most case, the dollar earned via revenue is characteristically reduced by operating expenses, as well as taxes and interests. A company that has a high level of the net margin is considered to be more profitable in relation to other firms in the same industry- investors are inclined to prefer this company. In a period of three years, the company’s level of the net margin was maintained above 2%. Although the net margin was established at 2.03% in 2011, the net margin of 2012 dropped slightly to 2.02. However, in 2013, the net margin of the company climbed to 2.14%; this is viewed as a significant improvement among investors (Yahoofinance 1). It shows the ability of a firm suppress expenses, as well as increase the profit margin per product. A firm can increase the product price slightly to experience an increased level of the product profit margin to realize a high net margin. With respect to the performance of AutoNation’s net margin, it is arguable that the company obtained impressive results in 2014; this performance is likely to attract investors due to expectation of similar performance in the future. Table 5 Source: Morningstar, AutoNation, Jun. 2014, Web. 2.2 Risk The risk of a firm is measured by a number of financial ratios; among the financial ratios that are used to assess the financial health of a firm includes the current ratio, quick ratio and debt to equity ratio. Quick Ratio Quick ratio is used to determine the ability a firm to pay its short term obligations with the most liquid assets; in this regard, inventory is normally eliminated from the most liquid assets. It is argued that inventory is not easily converted to cash; in this respect, quick ratio is calculated as a ratio of current assets (subtract inventory) to current liabilities. A firm that has a quick ratio of more than 1 is said to stand a chance of paying its short-term obligations easily; however, a quick ratio of less than one is believed to be associated with less ability of meeting the short-term obligations quickly. The quick ratio of AutoNation decreased constantly in a period of three years; the quick ratio declined from 0.27 in 2011 to 0.24 in 2012; as December 2013, the quick ratio dropped to 0.22 (AutoNation 1). The constant decrease in the level of the quick ratio may indicate that the quickest current assets are decreasing or the short term liabilities are increasing. This would adversely affect the company’s ability of meeting maturing debts and emerging expenses. It would also impact the company negatively as far as requesting a credit is concerned. Table 6 Source: Morningstar, AutoNation, Jun. 2014, Web. The Current Ratio The current ratio is another financial ratio that is used by financial analysts to determine the ability of a firm to meet its short term obligations. Creditors are normally interested to understand the ability of a firm to pay the debt once a credit has been extend to it by a lending institution. The current ratio is normally calculated as a ratio of current assets to current liabilities. A firm that has a current ratio of one or more than 1 stands a chance of paying its short-term liabilities; conversely, a firm that has a current ratio of less than 1 is inclined to face difficulties as far as paying the short-term liabilities are concerned. AutoNation is facing an increasing risk as the current ratio decreased in the last three years. Based on AutoNation’s financial statements, current ratio dropped from 1.09 in 2011 to 1.05 in 2012; the ratio reduced to 1.02 in 2013 (1). Generally, the ability of AutoNation to meet the short-term obligations is decreasing consistently. This may the ability of the lending institutions to offer AutoNation a credit due to reduced ability of the company to settle debts by the available current assets. Table 7 Source: Morningstar, AutoNation, Jun. 2014, Web. Debt to Equity Ratio The debt to equity ratio is observed by a majority of investors, financial analysts and scholars as an important aspect as far as assessing a company’s probability of facing insolvency is concerned. The debt to equity ratio is normally computed as a ratio of debt to equity ratio; this concept attempts to evaluate the capital of a company which is financed by equity and debt. Investors shun companies that are financed by a high level of debt; these firms are faced with a high level risk of facing financial difficulties. While a firm that is financed by debt normally evades a significant part of taxation, it is evident that a considerable level is risky, especially when the amount of debt exceeds the amount of assets. In this regard, it is advisable that a firm should balance how its capital is financed. The financial statements provided by Morningstar indicate that AutoNation faced an increasingly probability of experiencing the risk of insolvency as of December 2012; this is due to the fact that the long term debt of the company increased relative to equity (1). The ratio of debt to equity increased from 0.86 to 1.22 in 2011 and 2012 respectively; the ratio of debt to equity decreased in 2013. The ratio of debt to equity reduced to 0.88; in this respect, the probability of facing insolvency reduced as of 2013- this situation is likely to demoralize investor (Morningstar 1). Table 8 Source: Morningstar, AutoNation, Jun. 2014, Web. Table 9 Risk Current Ration 1.09 1.05 1.02 Quick Ration 0.27 0.24 0.22 Financial Leverage 3.27 4.27 3.84 Debt/Equity 0.86 1.22 0.88 Source: Morningstar, AutoNation, Jun. 2014, Web. 3.0 The Financial Projections of AutoNation Table 10 AutoNation’s Five Years Financial Projection ($ million). Base Year Year 1 Year 2 Year 3 Year 4 Year 5 Cash Flow from Operations 1 484 557 635 717 803 891 Capital Expenditures 2 161 185 211 239 267 297 Free Cash Flow 323 371 423 479 536 595 Terminal Value 3,966 Cash Flow Stream 323 371 423 479 536 3,966 Source: Morningstar, AutoNation, Jun. 2014, Web. The cash flow from operations is expected to increase consistently in the next five years; however, the cash flow from operations would increase at a decreasing rate. The cash flow is expected to increase by 15% in the first year; the rate would increase by 14% in the second year; in the 3rd, 4th and 5th year, the rate would increase by 13%, 12% and 11% respectively. It is expected that the profits from the company’s activities would increase at a decreasing rate due to stiff competition of existing and new firms in the industry. On the other hand, the capital expenditure would grow consistently in a period of five years; however, the capital expenditure would also grow at a decreasing rate. The capital expenditure would grow by 15%, 14% and 13% in the 1st, 2nd and 3rd year respectively. The 4th and 5th year would witness an increase of 12% and 11% respectively. While the cash flow from operation grows at a decreasing rate, it is expected that the capital expenditure would replicate the same trend The free cash flow would increase consistently in the next five years at a decreasing level; the 1st and 2nd year would face an increase of $371 and $423 millions. This would be followed by an increase to 479, 536 and 595 million respectively: the growth in the cash flow stream is expected to estimate the value of the firm. 4.0 The Value of a Firm Table 11 The Value of the Firm ($millions) Cash Flow Stream 323 371 423 479 536 3,966 Enterprise Value (NPV) $2,748 Debt 1,810 BS (Current & LT Portion) P. Stock -1,321 All PS - BS plus any accrued Div PS – footnotes Value to Common SH $2,259 Shares Outstanding 121 BS or current number Stock Target $ 18.67 Stock Price $59 Source: Morningstar, AutoNation, Jun. 2014, Web. A stream of free cash flows are used to determine the value of a firm; free cash flows that are expected to be generated in the next five years would be discounted at a rate of 18%. The discounting of the free cash flows resulted in a present value of $2,748,000,000. The company has a net debt of 1,810 million as of 2013; the treasury stock was quoted as (1,321) million at the end of 2013. The shares that are outstanding are 120,937,500; the value to the common shareholders was established at $2,259,000,000 as of the end of 2013. With reference to the value of the common shareholding of $2,259,000,000, the stock target established at $18.67. Given that the present stock is $59, an investor is likely to sell the shares of the company; however, this would be based on the fact that the cash flow from operations and other financial ratios would prevail in the near future. Table 12 The Free Cash Flow ($ millions) Cash Flow from Operations 465 CF STMT         Capital Expenditures 173 CF STMT         Free Cash Flow 292 335.8 382.812 432.57756 484.48687 537.78042 Source: Morningstar, AutoNation, Jun. 2014, Web. The cash flow from operations as of 2013 was estimated at $465 million; the cash flow that was related to the capital expenditures was estimated at $173 million; this resulted in a free cash flow of $292 million. The free cash flows for the five years are expected to grow at a decreasing rate; the first year would see a growth of 15%. The rate would be followed by a growth of 14% and 13% in the second and third year respectively; the fourth and third year would witness a growth of 12% and 11%. The industry is performing well; it is expected to perform excellently in the near future as the economy continues to recover from the financial crisis that hit a large number of economies in the world as of 2008 (SELECTUSA 1). Consumers are likely to purchase a large number of new cars as opposed to the old ones. AutoNation is inclined to focus significantly on the sale of new vehicles which would witness a considerable number of customers. This would boost growth of the automotive industry; the growth would also be underpinned by the US open investment policy and effective infrastructure. However, the industry is likely to be affected negatively by increasing oil prices (SELECTUSA 1) 5.0 Conclusion The automotive industry is likely to grow in the near future given the current situation: the US economy is associated with an open investment policy, improved infrastructure and a number of government incentives. Similarly, the economy of the US is improving, as the world economy is also witnessing growth; a majority of economies would continue to witness growth in the near future since there have been a rapid expansion of various economical sectors following the financial crisis (SELECTUSA 1). This explains the reason why the automotive industry in the US is expected to witness a growth; as a result, AutoNation would continue to experience a growth with respect to its net income and cash flows from operations. However, the competition is anticipated to stiffen in the near future among the existing companies; new auto firm are expected to enter into the industry due to a high profit growth in the industry. The stiff competition and high level of companies’ concentration in the market would result to a consistent decline in profits among various firms. This explains the reason why the profits of AutoNation are expected to increase at a decreasing level. However, it should be noted that the firm’s future cash flows would not be enough to lead to an increase in the share price. Generally, the industry would face stiff competition and the share prices would tend to decline (SELECTUSA 1). Works Cited AutoNation. Purdue U, n.d. Web. 21 Jun. 2014. < http://www.autonation.com/> Berman, Karen, and Joe Knight. Financial intelligence: a managers guide to knowing what the numbers really mean. Rev. ed. Boston, Mass.: Harvard Business Review Press, 2013. Print. Morningstar. AutoNation at Purdue and Purdue U, n.d. Web. 21 Jun. 2014. < http://quote.morningstar.com/stock-filing/Annual- Report/2013/12/31/t.aspx?t=XNYS:AN&ft=10- K&d=bddf3e73d6e1204c8ede8dbbfb7d27de > Morningstar. AutoNation at Purdue and Purdue U, n.d. Web. 21 Jun. 2014. SELECTUSA. The Automotive Industry in the United States at Purdue and Purdue U, n.d. Web. 21 Jun. 2014. Yahoofinance. AutoNation at Purdue and Purdue U, n.d. Web 21 Jun. 2014. < https://ca.finance.yahoo.com/q?s=AN> Appendices AutoNation 2011-12 2012-12 2013-12 Revenue USD Mil 13,832 15,669 17,518 Gross Margin % 16.7 15.9 15.8 Operating Income USD Mil 572 645 740 Operating Margin % 4.1 4.1 4.2 Net Income USD Mil 281 316 375 Earnings Per Share USD 1.91 2.52 3.04 Shares Mil 147 126 123 Book Value Per Share USD 13.95 13.97 17.05 Operating Cash Flow USD Mil 376 317 484 Cap Spending USD Mil -149 -161 -161 Free Cash Flow USD Mil 227 156 323 Free Cash Flow Per Share USD 1.54 1.24 2.62 Working Capital USD Mil 214 159 78 Read More