Republic Industries Bull's Pen
by Jim Surowiecki ([email protected])

The toughest time for used-car dealers is when buyers are flush. Boom times for consumers often translate into tough times for used-car dealers, especially in a world where new car prices are rising barely, if at all. If you can get a new car for a couple thousand dollars more than a used car, with low financing, why even bother to look at a "pre-owned" vehicle? While that seems to be a reason to be skeptical of Republic Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RII)") else Response.Write("(NYSE: RII)") end if %> and its attempt to bring the superstore concept to the car business, in fact, Republic's performance in this Goldilocks economy bodes extremely well for its future. With a foot in both the used-car and new-car camps, Republic has diversified smartly. And as the superstore concept gains greater credibility with car buyers, Republic's margins, and its profits, will rise. Auto retailing is a business that's been crying out for rationalization for decades, and Republic is the company that will provide it, if Wayne Huizenga has his way.

While Republic's real topline growth is coming, and will continue to come in the near future, from acquisitions -- acquisitions that have boosted the company's annual revenue to more than $10 billion -- it has also figured out how to deliver bottom-line performance, even at a time when the used-car market is hardly on fire. Republic is not, it has to be said, a short-term play. But over the next five years, this company is going to revolutionize the way Americans buy cars, both new and used, and it has a very good chance of becoming the Home Depot of automotive retailing.

Once a waste-management company, Republic is best known for its AutoNation USA megastores, which feature massive lots of used cars, a no-pressure sales approach, and excellent selection. As it happens, the 26 AutoNation megastores contribute less than 10% of Republic's annual revenues, the vast majority of which come from its new-car dealerships and its rental operations (Republic owns both National and Alamo). But the company's long-term future certainly depends on the success of the AutoNation concept. And while Republic did hit some snags early on in its attempt to figure out exactly what used-car buyers are looking for, its revamped operations -- which include a greater role for experienced dealers, a much speedier turnover of inventory, and leaner staffing -- have already begun paying dividends. AutoNation as a whole will be profitable this quarter, and many of the superstores already are in the black.

The thing to keep in mind when one looks at Republic is just how big the market that it's going after is. Americans buy close to 60 million cars a year, spending around $1 trillion.If Republic can claim just 7-8% of that market, you're looking at a company with $70-$80 billion in revenue. At the same time, studies suggest that 30% of used-car buyers buy their cars through classified ads, suggesting how much they dislike conventional used-car dealers. If Republic's decidedly atypical approach to selling used cars can bring in just a small percentage of that market in addition to the already dealer-friendly buyers, then it will become a retailing giant, along the lines of a Wal-Mart or Staples.

Of course, none of this really matters if Republic cannot turn those sales into profits, and here any investor would have serious doubts. Republic's gross margins have averaged around 17%, while its operating margins have meandered between 1-7%, hardly earthshattering. And although the company doubled its earnings in the last quarter, its P/E ratio is still a fairly hefty 27 (though that number is skewed by a fourth-quarter write-off). If companies should be valued on their ability to deliver profits, Republic doesn't look like such a good buy.

There are two reasons, though, why Republic's numbers are deceiving. In the first place, the company's cash flow growth has been strong, and its earnings have been eroded by the hefty amortization charges it's paying for its acquisition spree. More importantly, though, Republic is only going to reap real benefits from its superstore strategy once all the components are in place. In essence, Republic is wagering that it can achieve the same kinds of economies of scale in retailing cars that General Motors and Chrysler have traditionally enjoyed in making them. Those kinds of economies take time to achieve. They come as the result of centralized purchasing operations and of national ad campaigns. They come when Republic sells on its used-car lots the cars that its new-car dealers have accepted as trade-ins. They come from running the reconditioning centers at high volume. And, eventually, they will come when Republic uses its buying leverage to get greater discounts from the manufacturers. Republic is already the largest car dealer in America. As it continues to grow, so too will its ability to get the best prices. And all of that improvement will go straight to the bottom line.

It's possible, of course, that Americans aren't interested in a national brand for buying new or used cars. And it's possible that AutoNation's competitors, like CarMax, will beat it to the punch. But all the evidence of American consumer habits suggests that superstores offer unbeatable combinations of price and selection, and all the historical evidence suggests that companies that are able to slash transaction costs by centralizing purchasing and inventory end up reaping the benefits. Don't expect Republic to be a hot stock in the next three months. But as a long-term play, it's worth your attention.

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