One Less Challenge for AutoNation and Its Investors

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The U.S. auto industry is poised to test 2015's level of new-vehicle sales, and with a strong December could actually top it. That's great news if you're a dealership group, such as AutoNation (NYSE: AN), that generates more than half of its revenue from new-vehicle sales. Unfortunately, for AutoNation investors, the stock has traded mostly flat over the past year, but there was some good news recently in regards to its recall policy.

AN data by YCharts

What's happening

In September 2015, AutoNation announced it had stopped selling any vehicle at retail or wholesale with an open recall. The company made quite a bit of noise about the policy and even used it in advertising messages. AutoNation hoped it was an idea the industry would follow suit with and adopt, but that never materialized and it took a toll on the company's financials.

During the third quarter, management noted the Takata airbag, which was the culprit behind most of the recalled vehicles, had negatively impacted net income by $6 million after-tax, or about $0.06 per share. In fact, roughly 14% of AutoNation's used vehicle inventory was on hold due to the Takata airbag. That's a huge issue when you realize that dealerships need to turn inventory as fast as possible to keep their business healthy.

"I'm not big enough to change how the recall system works. I try. Valiant effort," said Mike Jackson, AutoNation CEO, according to Automotive News. "Conclusion: It is the way it is. Learnings: We still identify repairs or disclose. We're at a better place than we were when we started, but it's not everything we hoped it would be."

Not only did AutoNation lose sales at retail, its losses at wholesale increased and there were direct costs such as floorplan interest expenses, insurance, and storage costs related to the impacted vehicles. Now that AutoNation has decided to reverse its pledge and will sell vehicles with an open recall and include a disclosure, the company will be able to erase much of the expense that took its toll during the third quarter and part of the fourth quarter.

What's next?

Despite this positive development for investors, there are still challenges as AutoNation remains heavily tied to California, Florida, and Texas due to its store footprint -- which makes it more prone to revenue volatility depending on the health of those markets -- and while the auto industry is poised to remain selling at high levels, the new vehicle growth story has plateaued.

That doesn't mean AutoNation can't grow its top line, but it's going to have to achieve that through acquisitions.That said, AutoNation is America's largest automotive dealer and uses its branding and scale to its advantage, so if investors are interested in adding a dealership to their portfolio, this is as good as they come, and it just got better with its decision to retail vehicles with an open recall.

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