Options Trade – AutoNation, Inc. (NYSE:AN) Calls 
Thursday, January 29, 2015

**OPTIONS TRADE: Buy the AN Apr 2015 65.000 call (AN150417C00065000) at or under $1.10, good for the day. Place a protective stop loss at $0.45 and a pre-determined sell at $2.00.

by Ian Harvey

January 29, 2015

Introduction

AutoNation, Inc. (NYSE: AN), an automotive retailer in the United States, is scheduled to report next week on February 3, and it appears that it is setting up for good news on the earnings front.

In October, AutoNation delivered its 16th consecutive quarter of double-digit, year-over-year earnings growth. The company reported record profits of $0.90 for the third quarter, up 20% from a year ago and beating Wall Street's estimates.

Analysts expect new vehicle sales to reach nearly 17 million in 2015 for the first time since 2005, as consumers' confidence in the economy grows and they enjoy the benefits of the nearly 40% decline in gasoline prices in the past year.

Despite this positive backdrop and the stock's relatively inexpensive valuation -- trading at 17.5 times earnings compared with an industry average of 22 -- shares remain below their highs ahead of the company's next earnings report, which is great for this options trade.

Last week, Goldman Sachs (NYSE: GS) lowered its view on the dealer space to "cautious" from "neutral." And the investment firm downgraded AN to "neutral" from "buy," saying it expects flat auto sales in 2015 and regulation that could impact markups on retail auto loans. Its analysts maintained their $64 price target, which is 7% above recent prices.

This downgrade has stifled a breakout to new highs ahead of earnings which leaves an opportunity to execute this trade.

Technical Details

AutoNation Inc. is currently trading 2.14% below its 52-week-high, 30.21% above its 52-week-low. The 1-year range for the stock is $46.16 – $61.42.

AutoNation Inc (AN) has a price to earnings ratio of 17.59 versus S&P 500 average of 17.42.

The stock price has outperformed the S&P 500 by 0.4%.

AN is currently valued at $6.8 billion and closed the last trading session at $59.81.

The stock has a 50-day moving average of $58.7 and a 200-day moving average of $55.47.

Earnings

AutoNation last posted its quarterly earnings results on Tuesday, October 28th. The company reported $0.90 earnings per share for the quarter, beating the analysts’ consensus estimate of $0.86 by $0.04. The company had revenue of $4.90 billion for the quarter, compared to the consensus estimate of $4.80 billion.

During the same quarter last year, the company posted $0.75 earnings per share. AutoNation’s revenue was up 9.8% compared to the same quarter last year. Analysts expect that AutoNation will post $3.40 EPS for the current fiscal year.

AutoNation also remains undervalued through several metrics that investors tend to rely on: the company's trailing P/E of 17.3x is below the industry average, while the forward P/E of 12.8x is also below the industry average. AutoNation's price to sales multiple of 0.4x is 20% lower than the industry average and the price to cash flow multiple of 15.2x is well below the 54.3x industry average. Adding them up reveals that AutoNation is undervalued by 76%. Therefore, the company holds a buy rating.

Market Expansion

US light-vehicle sales have finally begun picking up momentum. The industry is highly linked to the performance of the overall economy. Fortunately, the current economic recovery is expected to last as authorities forecast the GDP to grow at CAGR of 2.5% over the next four years. The increase in consumer confidence as a result of GDP growth coupled with cheap financing, lower fuel prices and new models packed with state-of-the-art dashboards and fuel-saving technology should drive the demand for light vehicles ahead. Therefore, IHS forecasts US light-vehicle sales to reach 17.4 million in 2017.

Being the largest dealership company in the US, this market growth will benefit AutoNation more than the small rivals who don't operate at a scale the company does. In addition, the company's initiative of increasing its franchise base will help it acquire a bigger market share ahead: in the latest quarter, AutoNation completed the acquisition of Barrier motors, a premium luxury business in the Seattle-Bellevue market. The company now owns Mercedes-Benz Bellevue, Audi Bellevue, Porsche Bellevue and Volvo Bellevue in addition to its other showrooms. These franchises are expected to add $355 million to the AutoNation's top line this year. Moreover, the company also attained a new Porsche franchise in Orange County of California in the period, which is expected to open in 2016 and will bring annual revenue of approximately $100 million to the company.

Apart from the sale of new vehicles, AutoNation will additionally gain through its used-vehicle segment, which is expected to benefit from higher demand as well. This is because as economic recovery brings more money into the pocket of employed citizens, the benefits will also flow down to low-income or state-dependent citizens in the form of job creation and employment opportunities. In fact, the US-unemployment rate has already fallen to 5.6% in December, which is the lowest rate achieved in six and a half years.

Analysts Opinions

With Goldman Sachs lowering its view to "neutral" from "buy," it is a belief that the downgrade by Goldman is just plain wrong.

First off, Goldman's flat sales assessment flies in the face of calls from numerous industry experts.

The National Automobile Dealers Association forecast 16.94 million new cars and light trucks will be sold in 2015, up from an estimated 16.4 million in 2014, on pent-up demand and lower fuel prices. TrueCar, J.D. Power, LMC Automotive and AutoNation all call for almost 17 million in sales, just shy of the 17.3 million record annual sales set in 2000.

Looking at analyst sentiment toward AN, it appears to be caution as opposed to bearishness, with the majority of analysts rating shares a "hold." This indicates that they are waiting to hear confidence and upbeat sales projections from the company before sticking their necks out with a "buy" rating.

However, not all analysts are negative -- separately, TheStreet Ratings team rated AUTONATION INC as a Buy with a ratings score of A-. TheStreet Ratings Team has this to say about their recommendation:

"We rate AUTONATION INC (AN) a BUY. This is based on the convergence of positive investment measures, which should help this stock outperform the majority of stocks that we rate. The company's strengths can be seen in multiple areas, such as its solid stock price performance, impressive record of earnings per share growth, revenue growth, reasonable valuation levels and good cash flow from operations. We feel these strengths outweigh the fact that the company has had generally high debt management risk by most measures that we evaluated."

Highlights from the analysis by TheStreet Ratings Team goes as follows:

• The stock has not only risen over the past year, it has done so at a faster pace than the S&P 500, reflecting the earnings growth and other positive factors similar to those we have cited here. Turning our attention to the future direction of the stock, it goes without saying that even the best stocks can fall in an overall down market. However, in any other environment, this stock still has good upside potential despite the fact that it has already risen in the past year.

• AUTONATION INC has improved earnings per share by 20.0% in the most recent quarter compared to the same quarter a year ago. The company has demonstrated a pattern of positive earnings per share growth over the past two years. We feel that this trend should continue. During the past fiscal year, AUTONATION INC increased its bottom line by earning $3.05 versus $2.53 in the prior year. This year, the market expects an improvement in earnings ($3.40 versus $3.05).

• Despite its growing revenue, the company underperformed as compared with the industry average of 9.9%. Since the same quarter one year prior, revenues slightly increased by 9.8%. Growth in the company's revenue appears to have helped boost the earnings per share.

• Net operating cash flow has increased to $242.00 million or 27.70% when compared to the same quarter last year. The firm also exceeded the industry average cash flow growth rate of -6.44%.

Also, analysts at Zacks reiterated a “neutral” rating and set a $63.00 price target on shares of AutoNation in a research note on Friday, December 5th.

There are currently fourteen analysts that cover AN. Of those fourteen, three have a Buy rating, nine have a Hold rating and two have a Sell rating. On a consensus basis this yields to a Hold rating. The consensus target price stands at $53.38.

Conclusion

With AutoNation's record profits in Q3, sales of new vehicles at its dealerships jumping 12% last month, and gasoline nearing $2 a gallon, expect a strong report that exceeds the current conservative expectations.

Concerns over the future of auto sales largely stem from the anticipation of rising interest rates. Higher rates would impact car buyers and AutoNation itself, as the company carries a fair amount of variable debt, however, the central bank has continued its dovish stance in the near term, which is a good thing for borrowers and for the health of the auto sector.

One more positive is that with the past four reports, AN has moved an average of more than 9% from low to high in the two days preceding and two days following its earnings release.

Therefore, based on the facts above the following options trade is recommended…..


**OPTIONS TRADE: Buy the AN Apr 2015 65.000 call (AN150417C00065000) at or under $1.10, good for the day. Place a protective stop loss at $0.45 and a pre-determined sell at $2.00.



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Options traders win because they are successful.



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