While Wall Street obsesses over new vehicle GPU trends and the impact of electric vehicles on margins, a quiet revolution is brewing within AutoNation's used car business. A closer examination of their Q1 2024 earnings call [Q1 2024 Call] reveals a strategic shift in inventory management that could have a significant impact on their used car profitability in the coming quarters.

The narrative around AutoNation's used car performance has been one of struggle. Tight availability, a return to historical depreciation patterns, and lower demand for high-priced vehicles have been cited as the primary culprits for the moderation in used car PVRs. Indeed, both the Q4 2023 [Q4 2023 Call] and Q1 2024 [Q1 2024 Call] earnings calls highlighted these challenges.

However, a subtle but crucial shift in messaging emerged in the Q1 call. Mike Manley, AutoNation's CEO, stated that the team has 'completed the inventory alignment actions' and has experienced 'improvement in unit profitability in each month of the first quarter as we had expected.' This language signals a proactive approach to aligning their used car inventory with shifting market dynamics.

The market factor impacting used vehicles, as highlighted in the Q4 2023 call [Q4 2023 Call] included tight availability, a return to historical depreciation patterns, and lower demand for high-priced vehicles. AutoNation's planned actions were to align inventory levels and the turn rate with the market. The company shared its view that used vehicle PVRs would improve late in the first quarter.

This suggests that AutoNation has moved beyond simply reacting to market forces. They have actively adjusted their sourcing strategies, likely focusing on acquiring vehicles in the sweet spot of customer demand – the under $20,000 price band. Tom Szlosek, CFO, confirmed this trend, noting a 5% increase in same-store unit sales for vehicles priced under $20,000 in Q1.

This shift towards lower-priced vehicles is a shrewd response to several converging trends. Firstly, it addresses the affordability concerns of a significant segment of customers squeezed by inflation and rising interest rates. Secondly, it creates a buffer against the increasing availability of new vehicles, which, with their attractive financing options, pose a competitive threat to high-priced used cars.

Furthermore, AutoNation's deliberate inventory reduction in Q1 is significant. The used vehicle inventory days decreased from 39 in Q4 2023 to 31 in Q1 2024. This indicates an emphasis on accelerating inventory turn, a critical factor in maximizing profitability in a normalizing used car market.

The company is effectively creating a virtuous cycle. By focusing on faster-turning, lower-priced used vehicles, they can generate higher unit profitability, even as overall used car margins remain under pressure. This strategy is evident in Manley's confident assertion that they 'see upside in our used vehicle margin.'

Here's where the hypothesis gets interesting. AutoNation's used car PVR in Q1 2024 was $1,473. Manley suggested a return to the $1,800 range is achievable. However, he also cautioned that analysts should factor in the impact of AN USA, their standalone used car stores, which have a structurally lower used car margin due to their distinct business model.

Let's assume AN USA accounts for roughly 10% of AutoNation's total used car sales. If we remove AN USA from the equation, the implied used car PVR for their franchise business in Q1 would be approximately $1,636. This figure already reflects significant improvement compared to the overall $1,473 figure.

If AutoNation can continue to execute its inventory alignment strategy and further accelerate inventory turn, achieving a $1,800 used car PVR for their franchise business in the coming quarters is not just a possibility – it's a strong likelihood.

Projected Growth of AutoNation Finance Portfolio

The following chart illustrates the projected growth of AutoNation Finance's loan portfolio based on statements made by CFO Tom Szlosek in the Q1 2024 earnings call.

Wall Street may be captivated by the electric vehicle narrative, but AutoNation's focus on optimizing its core used car business could prove to be the real engine of value creation in the years ahead. This strategic shift, coupled with their strength in CFS and the burgeoning after-sales business, positions them to not just weather the current market uncertainties, but thrive in the long term.

"Fun Fact: Did you know that AutoNation sells a used car every two minutes? That’s a testament to their massive scale and reach in the used car market."