Cars.com Contends With Uneven Dealer Demand (Downgrade)

seekingalpha11-20

Cars.com recently reported Q3 2024 results, matching revenue estimates but missing earnings projections.Financial trends show slight revenue growth, improved operating income, and strong free cash ...

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But significant recovery may not occur until 2025.   deepblue4you/iStock Unreleased via Getty Images Investment Outlook Cars.com (NYSE:CARS) recently reported Q3 2024 financial results, matching revenue estimates but missing consensus earnings projections. I previously wrote about CARS in October 2023 with a Buy outlook due to improved forward guidance and increasing earnings per share. However, a major IT outage in the summer of 2024, along with continued price inflation in the total cost of car ownership, has impacted consumer and dealer demand and profitability. While management has reiterated a 5% topline revenue growth rate for fiscal 2024, dealer segment challenges may continue to temper growth prospects for a time. Since it appears the stock is fully valued at its present price, I’m neutral (hold) on CARS for the near term. CARS’ Market And Approach Per a 2022 used automobile purchase market research report by Mordor Intelligence, the U.S. market was estimated at approximately $196 billion in 2021 and was expected to exceed $302 billion by 2027. If achieved, this growth would represent a CAGR (Compound Annual Growth Rate) of 7.51% from 2022 to 2027. The pandemic and post-pandemic eras produced substantial disruptions to the automobile demand dynamic and supply chain management. Also, in response to high inflation, the rise in interest rates reduced affordability for a significant number of consumers. And, more recently, rising insurance rates as a result of the recent inflation have increased the carrying cost of automobiles. Prominent competitors or other industry players include:  CarGurus (CARG) TrueCar (TRUE) CarMax (KMX) CarBravo AutoTrader.com AutoNation KBB.com CarsDirect.com Edmunds.com CarFinder.com  Cars.com’s approach is to integrate its consumer website with car dealerships to automate consumer shopping processes while providing value-added services, such as financial services. CARS’s closest competitor is arguably CarGurus (CARG), with some differences being a greater focus on price for CARG. Recent Financial Trends Total revenue by quarter (columns) has grown only slightly due to a large dealer IT outage in the summer, which have begun to recover from. Operating income by quarter (red line) has improved slightly sequentially because of improving SG&A efficiencies.   Seeking AlphaThe degree of operating leverage has trended lower in recent years, although the two most recent quarters have produced encouraging results as operating costs have moved lower on increasing efficiencies.   Seeking AlphaGross profit margin by quarter (blue line) has fallen as a result of higher product and technology expenses. Selling and G&A expenses as a percentage of total revenue by quarter (orange line) have trended lower due to increased efficiencies.   Seeking AlphaEarnings per share (Diluted) have improved sequentially and year-over-year on lower operating costs and modest topline revenue growth.   Seeking Alpha(All data in the above charts is GAAP.) For balance sheet results, CARS ended the quarter with $49.6 million in cash and equivalents and $465.0 million in total debt, all of which is long term. Over the trailing twelve months, free cash flow was an impressive $165.1 million and capital expenditures were only $2.6 million. The company paid $31.3 million in stock-based compensation in the last four quarters, so free cash flow net of SBC was a still strong $133.8 million. SBC as a percentage of revenue over the trailing twelve-month period was only 4.4%. The net dollar drop in stock outstanding for the last four quarters was valued at $43.7 million, so CARS has been buying back its stock at a reasonably strong pace. I’ve prepared a major financial and operating metrics table for handy reference:       Metric Amount   EV/Sales - FWD 2.3   EV/EBITDA - FWD 7.8   Rev. Growth Estimate - FWD 5.0%   2024 EPS Estimate - FWD $1.78   Price/Sales 1.7   Revenue Growth - TTM 6.0%   Net Income Margin 5.5%   EBITDA Margin 22.2%   Market Capitalization $1,210,000,000   Enterprise Value $1,630,000,000   Operating Cash Flow $167,660,000   EPS (Fully Diluted) $0.59   Free Cash Flow/Share $2.16   Seeking Alpha Quant Score Buy - 4.40   Click to enlarge (Source - Seeking Alpha) Why I’m Neutral On Cars.com The company has experienced slack sales demand during the most recent quarter but is seeing a return to more normal demand patterns in October across its various lines of business, hinting at a potentially stronger Q4. While marketing and sales expenses decreased due to improved efficiencies, gross margin dropped on higher product and technology expenditures. The graphic below shows the frequency of various typically negative keywords in the most recent management call with analysts as a sentiment indicator of sorts:   Seeking AlphaThe chart shows that some of the company's customer bases faced severe challenges in July and August from IT outages as well as continuing negative macroeconomic trends affecting buyer demand and dealer profitability. As a result, dealerships cut back on their IT spending during that period and have been moderate in their resumption. The firm reiterated its expected fiscal year 2024 revenue growth of 5% at the midpoint of the range. If that growth rate is achieved, the OEM and National segments will account for a higher growth rate and dealers for a lower rate of growth as they continue to slowly recover from the summertime IT outage. So, the company's dealer segment is the real source of drag on its growth path in the coming quarters. Management is seeking to leverage its growing OEM endorsement to increase dealer awareness and stimulate dealer sales, but that's likely a longer-term strategy and not a short-term tactic. My DCF calculation for CARS is shown below, with assumptions of $1.78 forward earnings per share and a 10% discount rate (4.4% 10-year + 5.6% ERP): GuruFocusThe DCF suggests that the stock is essentially fully valued at its present price of around $18.70. However, if the company returns to a higher growth rate while retaining its cost efficiencies, there may be more upside to the stock in the short to medium term. The key for CARS is how quickly dealer demand will rebound and to what degree since dealers are facing consumer demand plateauing in recent quarters as the total US vehicle sales chart shows here: St. Louis Federal ReserveSo, my outlook for Cars.com in the short term is only moderately improving revenue fundamentals and the same for earnings.  With an apparently full stock valuation at its present price, my near-term outlook is a Hold pending further dealer recovery in demand for new IT initiatives, which may not occur in strength until 2025, despite management’s optimistic talk to the contrary.","kind":"highlight","is_publish_news":true,"is_publish_highlight":false,"is_publish_live":false,"is_publish_wemedia":null,"editions":null,"column":"","sentiment":"-1","news_tag":"analysis","news_rank":0,"symbols":[],"gpt_button":1},"commentList":[],"isCommentEnd":true,"newsSizeData":{"likeSize":0,"commentSize":0,"repostSize":0,"favoriteSize":0,"likeStatus":false,"favoriteStatus":false},"APP":{"userAgent":"Mozilla/5.0 AppleWebKit/537.36 (KHTML, like Gecko; compatible; ClaudeBot/1.0; +claudebot@anthropic.com)","isDev":false,"isTTM":true,"deviceId":"web-server-community-laohu8-v3","version":"4.29.3","shortVersion":"4.29.3","platform":"web","vendor":"web","appName":"ttm","isIOS":false,"isAndroid":false,"isTiger":false,"isTHS":false,"isWeiXin":false,"isWeiXinMini":false,"isWeiBo":false,"isQQ":false,"isBaiduSwan":false,"isBaiduBox":false,"isDingTalk":false,"isToutiao":false,"isOnePlus":false,"isHuaWei":false,"isXiaomi":false,"isXiaomiWebView":false,"isOppo":false,"isVivo":false,"isSamsung":false,"isMobile":false},"href":"/m/news/2484088039"}