Description

Sonic is an auto-retail player with two segments, traditional franchised dealerships, and a used-car retail chain named EchoPark. The franchised dealer segment is a stable, fine business, but not one we are over the moon for. Alas, we believe investors have overlooked the real gravy —EchoPark — which we believe could add $8 of EPS to Sonic by mid-decade, and over $20 by 2030. The stock is presently selling for $46.

EchoPark

EchoPark (“EP”)  is Sonic’s used car dealer concept and the key driver in our thesis. They presently operate 35 locations, selling at a run-rate of 85k units/year. 

EP operates digitally-driven, high-volume used car stores. A key differentiator is their simple, no haggle, no negotiation buying process. The target market is 1-4 year old, barely-used vehicles (mid $20k ASPs), which are sourced from trade ins, wholesale, and partially from Sonic's franchised dealer lots (e.g. off-lease). 

The EP segment is in its early innings, and we are interested in Sonic’s aggressive ambitions to grow the chain.

The front-end car sale is used as a loss leader (cars are priced 10% below KBB) to drive traffic. EP then tries to attach finance (1/3 of F&I rev) & insurance (2/3 of F&I rev) in the back-end of the sale for origination fees (we hear that about 60-80% of an insurance premium goes to the originator as commission). (“Insurance” in this context means extended warranty policies.) About 80% of customers finance and 50% of customers purchase extended warranty. 

Sonic plans to expand the business by building out 25 stores/year into 2025 (i.e. 140 stores by 2025) thus growing from $2.7B to $13B in revenue. Looking further out, we estimate the business can grow to generate $900m of net income on $35B of revenue by the early 2030s. Note: Sonic started reporting EP as a segment in 2019. 

Company guidance for the economics of a typical EP transaction at a mature (2 year old +) location, on a gross-profit basis:

On a per-vehicle basis, we think about after-tax profit in the following way:

We have high confidence in net income per vehicle math, which we believe to be close to mid/high-$500s. Given this is a dealer business, net income as % of GP is a better indicator of net margin, which we note here is 26% on this basis (and 2-3% on a revenue basis). 

Simply for reference, we note EP’s LTM results for mature stores (open 12mo+). We see F&I GP is already above guidance of $2,250/unit, though front-end GP is weak as of late, primarily due to (temporary) dislocations in the delta b/w wholesale and retail car prices.

Valuation

Management’s unit guidance is 575k units selling through 140 locations by 2025. Most of the store buildout (~80%) will be small delivery hubs which cost $1-2m in initial capex, 3-6mo to breakeven, and 2 years to maturity. The small locations bring EP closer to the consumer without costly (CVNA-esque) last mile delivery. We estimate $400m of initial capex is needed for the buildout. We invite those interested in more details to the 4-wall slide on the IR deck (pg 16).

Given 575k units @ $555/unit in net income, we expect the 140 EP locations to generate roughly $320m after-tax by 2026, or $8/share in EPS. And, in 2026, we value EchoPark at 12x earnings, thus $96.

Management has expressed post-2025 ambitions for EP, which we ponder … The entire used car market transacts 40m units. EP’s TAM (1-4 year old used) transacts 15m units/year. Management believes that, at maturity (we think this means early 2030’s), they can penetrate 1.5-2m of the 15m (10-13% share). For reference, we are already seeing mature EchoPark stores capturing 10-14% share in their regional markets. We hesitate to put much weight on 2030 predictions, but, regardless, we'd like to think about the potential.

I note that for our bull 2030 prediction, we further consider that management said SG&A/GP may drop from 60% as guided, to 55%. And, there were comments about making the front-end pricing strategy less aggressive over time.

Summary of Valuation

Sonic’s Franchised Dealer Segment

Historically, the dealer business was viewed as a car-trading and distribution business, neither of which the OEMs wanted to be distracted by. Alfred Sloan originally described the franchised dealer as a store run by a local businessperson — a well-seasoned specialist in the OEM’s vehicles who welcomes neighbors into the showroom, driven by the belief that dealing with a friendly, local merchant results in a more congenial and convenient transaction for the customer. I have not taken a tally, yet I am not so certain that today, Americans describe the car buying process as friendly, congenial, or convenient.

Furthermore, historically, innovation in auto retail has been glacial. This makes us believe that the industry is primed for disruption, which poses risks.

On the new car side, we are concerned about OEMs pushing DTC. On the other hand, we note that if dealers may become more efficient, playing a fulfillment-center-like. Further, we believe post-chip shortage inventory discipline in new car dealers is an upside of note.

In parts, we are concerned about EVs requiring less maintenance. However, we are also enthused by EVs being more complicated, thus, dealers may gain share over local car repair shops.

On F&I, we are unsure about the interaction between EVs and extended warranty demand.

Lastly, in used, we believe there is digitally-driven competition brewing from Carvana et al.

Sonic’s management guides consolidated revenues to reach $28B by 2025 (including $3.2B from RFJ Auto acquisition closed Dec 2021). Subtracting out the $13B EchoPark business, we are left with a $15B franchised dealer segment. We believe the dealer business faces uncertainty. There is an unpredictable concoction of both tailwinds and headwinds on all segments — new, used, parts/service, and F&I. Thus, we imagine a base case where the business generates a depressed 2% net income margin on the $15B of revenue = or $300m. This translates to $7 of earnings. In 2026, we value the franchised dealer segment at 6x earnings, primarily out of uncertainty surrounding each segment of the business, thus $42 per share.

Management

Some things of note … The co-founder and chairman of Sonic is O. Bruton Smith, a 94 year old legend of the auto and racing business. His son, David Smith, is CEO. Combined, the Smiths own over 30% of the company, which we like.

Risks

Overreliance in EP on F&I segment, execution in ramping EP from 35 to 140+ stores, potentially weakening balance sheet from EP capex and dealer M&A, secular long-term changes in franchised dealer new sales, used sales, parts/service, and F&I businesses, and, given this latter, management's strategy to continue expanding the franchised dealer business though M&A.

Investment Summary

In summary, in 2026, we believe Sonic consolidated to be earning $15 in EPS. We estimate EchoPark to be worth $96 and franchised dealers $42, for a combined value of $138. This represents a 206% upside, or a 25% rate of return over five years.

Catalyst

Underappreciated EchoPark segment