Strategy

21 December 2010 Americas/United States Equity Research

Auto Retail Initiation

SMALL & MID CAP RESEARCH

Riding the New Vehicle Recovery Wave

We are initiating coverage of the auto retailer group with a positive segment view, believing that above expectations EPS growth may push select stocks higher over the next 12 months. We believe the combination of rising SAAR, fewer dealers, tight inventories and lower cost structures may lead to EPS upside. There are three factors behind our positive view. First, top-line growth should accelerate, driven by continued SAAR gains. This bodes well for the stocks, given the high correlation between the stocks and SAAR growth. The auto dealer stocks have outperformed in 2010 on the back of improving SAAR and we expect SAAR growth to accelerate to 11% in 2011. That SAAR growth will be spread across 13% fewer dealers (since 2007), leading to greater dealer productivity. Second, operating leverage is high, strengthening our conviction in upside EPS potential. The companies are generating more EBIT dollars per vehicle sold than ever before and an improving SAAR along with tight inventories should further enhance that metric. As operating leverage is realized, we see 10-15% of earnings upside potential and limited downside risk to the consensus. Third, current multiples, while above average, are sustainable in this recovery period. A premium multiple is justified in a SAAR growth period. We are in the midst of that phase, which should last at least through 2011. We initiate coverage on AN and LAD with Outperform and on PAG and GPI with Neutral ratings. In AN, we see a best-in-class operator with the greatest operating leverage to an improving SAAR. Our $34 target price implies 24% upside potential. In LAD, we see a well run business with high operating leverage and an attractive valuation. Our $18 target price implies 43% upside potential.

Research Analysts Gary Balter 212 538 4228 gary.balter@credit-suisse.com Simeon...