Why Analysts Love These 2 Car Sales Platforms, And Avoid Dealers

Remember when every car dealer on the street had no inventory and lead times extended up to a year for specific brands? The chip shortage causing supply bottlenecks in motor vehicles is taking a back seat to catch its breath and hopefully never come back into the arena.

What this means for the average consumer considering purchasing a new - or used - vehicle is twofold: first, better prices are on the horizon and already making their way into the market.

According to Cox Automotive and its Manheim index, which seeks to track the indexed market value of cars, June 2023 saw the most significant price contraction since April 2020. Secondly, rising interest rates will affect demand trends, as the average monthly car payment has been increased to $733 a month.

Boiling things down, investors can begin to dig into what markets are liking - and disliking - amid these developments, with the hopes of riding a new wave of profitability in their portfolios. Here are the two favorites and some others that are being avoided.

Cars.com

Investors can sometimes take advantage of market inefficiencies. However, a brave stomach is called for to achieve above-market returns when they indefinitely occur. Cars.com NYSE: CARS has found itself amid an unjustified sell-off, especially after blowing past earnings expectations.

Analysts were expecting earnings per share of $0.12 for Cars.com in the second quarter of 2023. To their surprise, the company came in hot, reporting EPS of $1.37 for a massive 11x surprise. Investors can and should take away two things from this dynamic.

Markets are mixing up the company's business model with that of all the regular dealers being negatively impacted by price declines, causing the stock to fall deep in undervaluation territory despite the massive tailwinds it now has as support.

Wall Street analysts, being the diligent beings they are, are barking at the right tree. Target prices fall on a consensus of $23.85 a share for Cars.com stock, implying an attractive 26.5% upside from today's prices.

Furthermore, EPS expectations for the next twelve months would reflect a jump of 27.3% to boost the stock's valuation further. All else being equal, the stock price should follow the rise in EPS since it typically drives stock prices, mirroring price target upside for a justifiable purchase consideration today.

Management guidance raises revenue and margin targets for the next quarter and full-year 2023; the earnings presentation also highlights a critical financial metric showing stratospheric jumps.

Free cash flow (operating cash flow minus capital expenditures) rose from $7.3 million in 2022 to $22.8 million in the last quarter. As any business's lifeblood, shareholders can expect a similar jump in full-year net income and other benefits, such as share repurchases.

CarGurus

Following a similar story, almost to the letter, CarGurus NASDAQ: CARG beat earnings expectations by nearly 2.5x, yet the stock sold off right after the announcement.

Despite the market's confusion, analysts are clear on the online dealership platform's potential during these pivoting times, so they have agreed on a consensus price target of $23.17 for this stock. Similarly to Cars.com, this rating would represent a 29.3% upside ceiling from today's prices.

Following the same logic, analysts are placing the next twelve months of expected EPS growth at a similar 27.1%, placing the needed foundation for the coming rally.

In all its forward-looking glory, the broader market is giving investors a very subtle though powerful hint regarding where it wants to push these two stocks. A comparison of forward price to earnings ratios is needed to translate the market's message.

The auto dealership industry currently carries an average forward P/E of 13.4x, while Cars.com and CarGurus trade at superior multiples of 31.8x and 15.0x, respectively. Why should investors get excited about these two stocks being more 'expensive' than the overall industry?

Built Different

Traditional dealerships, which hold lots of physical inventory as their primary business model, are being disfavored by the market today. Names like AutoNation NYSE: AN and Penske Automotive Group NYSE: PAG carry forward P/E of 7.2x and 10.2x.

Investors can take this as a simple message: markets are willing to pay a 'premium' price for those online dealer platforms relative to the traditional physical dealer model.

Why? Since car prices are declining and expected to keep falling, inventory values - and sales margins - will fall right along in the balance sheet of those traditional dealers.

Once again, those diligent beings at Wall Street have their cards right; analysts expect EPS declines for AutoNation and Penske to 9.5% and 5.5%, respectively. The growth will go into the names facilitating the sale of better-priced vehicles, rather than looking to profit by flipping inventory.