Credit Snapshot: Lithia Motors (LAD)

We summarize the credit fundamentals of Lithia Motors.

May 20, 2025

Credit Trend: Stable

Summary credit profile:

LAD has posted steady growth as the #1 franchise dealer with a heavy reliance on M&A as part of its rapid expansion over the past cycle, including $8.3 bn in deals since 2019. LAD has materially grown both new and used unit volumes. LAD has been expanding in multiple growth areas such as digital retailing and more recently captive finance (not to be confused with the Finance and Insurance revenues of their franchise dealers). For more background history, see Credit Crib Note: Lithia Motors (9-3-24).

While the consumer cycle and tariffs justifiably get the most attention in autos lately, the franchise dealer issues will be more about working capital management, floor plan mix, and coordinating with their manufacturing partners (OEMs) to minimize the tariff disruptions while sustaining volumes. The dealers are much less exposed than the supplier-to-OEM chain to financial damage from tariffs. Among the challenges in 2024 for LAD were weaker same-store profitability metrics and higher leverage, but trends improved in 1Q25 during a strong pre-buying period ahead of tariffs. For now, the factors net out to “stable” credit trends as LAD gets more selective in M&A.

Relative value:

LAD bonds trade tight for the BB tier as a consumer cyclical retail operation with a big M&A appetite, but LAD is comfortably wide to the BBB tier with LAD bond spreads in the midrange between the BBB and BB composite OAS levels. LAD has the appeal of being a safer HY consumer play in a tier of the credit markets where the word “retail” has a jaded history. The variable cost structure (low fixed costs) make LAD distinctive in the broad auto category in terms of its tariff risks.

LAD has 3 index bonds as a BB2 composite in short to intermediate maturities with below market coupons (4.625% of 12/27, 3.875% of 6/29. 4.375% of 1/31). LAD attracts crossover investors from the BBB tier since auto retail and services present lower business risk than high fixed cost auto suppliers and OEMs. Reliable cash flow and replacement cycles combined with the very high margin Parts & Service revenue to support profits across the cycles. LAD’s captive finance operations are off to a good start as a profit growth business line, but asset quality trends merit scrutiny if the consumer sector weakens.

Business risk:

LAD presents an above average business risk profile vs. auto retail peers such as AutoNation (AN) and Penske (PAG) based on LAD’s aggressive M&A program and heavy investment in digital retail and used cars. In the “long game,” those investments put LAD ahead of the curve, and the post-tariff market will give used vehicle operations some renewed growth opportunities. Auto dealers present less financial risk in a downturn than suppliers and OEMs with their high fixed cost exposure.

For credit risk (in contrast to equity valuation challenges), the variable-cost-heavy nature of dealer inventory and the ability to adjust brand and model selection gives auto retail much greater flexibility to adjust brand and model mix to the eventual auto tariff reality. One important element is how the Japan and South Korea trade talks play out. Closely monitoring dealer trends and stress points for some of the more import-dependent brands will be a challenge, but the largest base of US-produced vehicles in the “import brands” (“import” as in not legacy Detroit 3) will be something the Big 6 public dealers will be able to adjust to without creating major financial risks. That sure does not mean it will be easy.

The heavy investment in used vehicle operations offer some mitigating factors for LAD in what is likely to be a fresh round of consumers shifting back toward used vehicles as tariffs put upward pressures on new vehicle prices. That is a silver lining side effect for used auto retail from the otherwise damaging tariff actions. The used car business will see higher prices and solid demand based on affordability, but it comes at a cost to new vehicle volumes. As the #1 new vehicle retailer, the ability to leverage captive trade-in vehicles can be a sourcing advantage for used inventory even as LAD leverages their increasingly developed digital capabilities and omnichannel strengths to compete with CarMax and Carvana in that space. Captive auto finance earnings in new and used will allow for some earnings differentiation vs. franchise dealer peers.

Like some other auto retailers, LAD has expanded in the UK. The long-term strategy targets growth and market share, and LAD is pulling away from franchised dealer peers across multiple avenues of expansion. M&A, international, and captive finance bring more execution challenges, and the tariffs and consumer cycle will offer a fresh round of tests in making these strategies work.

Tariffs:

In reviewing the mix of risk factors from auto tariffs on new vehicles and parts/suppliers, there are a lot of variables at work. For auto retail, the overriding worry is same store volume weakness on price impacts. The earnings calls and trade press commentary have been voicing the view that the dealers are much better positioned and their partnership with the OEMs will make for an orderly process for auto retail. That is a low bar to clear given how challenging the market will be for the auto suppliers and OEMs.

The net effect is that tariffs are negative for “anything auto” even if just on the uncertainty and morphing (and often inconsistent and even reversible) policy actions. While tariffs and the relative exposure to manufacturing material cost changes (steel, aluminum, copper, possibly semis and electronics) will drive the “cost of sales” line higher for suppliers and OEMs, the end result is still somewhat of a moving target (including for domestic content and allocated parts tariffs for US-produced transplants).

The clear trend for margins will be negative in manufacturing while retail volumes could suffer on price increases. The SAAR forecasts from the dealers seem to run in a 1-million unit range with midpoints generally showing 16 handles. All parties still need a lot more input ahead on trade and tariff negotiations.

The effects in the end will be very much dependent on the policies and actions of the OEM partners, who have a vested interest in the health of their dealer network. Attempts to recoup tariff costs via selling prices will tie into numerous other factors including “cost sharing” with supplier chains, OEM support and dealer/customer incentives.

The brand/model diversification story has its limits and the mix of US-manufactured “import brands” can vary by dealer. The same is true for the component mix using imported, high value-added parts (e.g. engines, transmissions). The content mix and where the vehicle was produced can vary for the leading import brands across the Japanese, South Korean, and German OEMs. Many import models also source parts and vehicles from Mexico and Canada.

For 1Q25, the leading brand revenue mix for LAD included Honda at #1 (13% of brand revenue) Toyota #2 (11%), Ford #3 (10%), BMW/Mini at #4 (9%), and Stellantis (legacy Chrysler/Ram/Jeep) at #5 (8%). Legacy Domestic was 25% in total. The Japan and South Korea talks are dragging on, and the bigger EU battle will come later with pharma tariffs. As a frame of reference, the UK “deal” (more like a “loose, incomplete framework”) was a de facto tariff-based quota for UK autos.

Profitability:

Given the M&A history, same-store metrics are more useful at the operational level. The M&A driven growth is impressive, but the same store adjustments also help tell the story in traditional retail metrics fashion. LAD same store profitability struggled in new vehicles in 1Q25 with the other business lines showing favorable same store trends. Same store unit volumes were positive for 4Q24 and FY 2024 and for new vehicle revenues, but same-store gross profits growth was negative. We break those out in the charts below. The sticker shock in new and used vehicles since 2019 is evident in the price details in the charts below. Now the tariff impact could add to that.

The record total revenue is a testament to LAD market share ambitions and capturing more value across the service chain including Aftersales (“Parts and Services” a common term for that unit), finance, used vehicles, and building out digital operations. As a reminder, the “mid-term” goal is $40 bn to $50 bn in revenues and long-term goal is $75 bn to $100 bn. That implies a lot of M&A over time for an industry leader with only around 1% market share of “total new and used.” LAD is targeting 5%. The industry is very fragmented, so it is about M&A timing, volume growth new vs. used, OEM support, and pricing.

Operating profits peaked in FY 2022 with the boom in used cars and despite the tightening cycle. Adjusted EBITDA has been in a narrow range from a high of just under $2 bn in 2022 in the peak earnings years to $1.6 bn in FY 2024. We highlight the exceptionally profitable, high margin parts and services business line (“Aftersales”) in the charts below and the clear potential to grow the captive finance business. That diversification and less volatile earning streams also serve to reduce business risk across time. The aftersales business has pricing power to pass through tariff costs on parts.

Balance sheet:

LAD has a more complicated business mix and balance sheet profile, so the analytical framework needs some tweaking including adjustments for floor plans and nonrecourse debt which LAD breaks out in detail each quarter. Adjusted net debt to EBITDA was 2.47x at 1Q25 vs. 2.31x at 1Q24. That compares to 2.56x at FY 2024, which was higher than 1.83x in 2023. The Net debt/Adj. EBITDA bank line covenant max is 5.75x. The target range is 2x to 3x. The leverage low was in 2021 at 1.1x, half the 2.2x back in 2018. Adjusted EBITDA in 2024 was down by -8.4% to $1.62 bn on an adjusted basis ex-finance. For 1Q25, adjusted EBITDA was up by 17.1% YoY vs. 1Q24 while LTM EBITDA for 1Q25 was down slightly (-4.7%) YoY.

The cash flow chart below tells a simple story of the very high rate of acquisitions as LAD pursues its growth plan. An important point is that LAD has articulated ambitions for investment grade credit ratings with that interest sharpened by the goal of capturing more of the auto value chain with DFC and seeing that translate into LAD’s valuation multiple.

We again emphasize that the captive finance operations of Driveway Finance Corp should not be confused with the Finance and Insurance (F&I) operations of the dealers. The greater margin for LAD by using its captive capability has been covered in earnings calls. DFC financing is one more menu item for customers and dealers. The F&I business line is one of the lead profit generators for LAD at over 25% of gross profits. DFC is reshaping the balance sheet with more nonrecourse debt and ABS usage ahead.

Driveway Finance Corporation (DFC):

DFC continues to post rapid growth in average managed receivables in 1Q25 as origination grew by over 26% YoY in the pre-tariff rush to $4.1 bn. That came after flattish origination volumes in FY 2024 vs. FY 2023. DFC posted higher penetration rates of 13.7% in 1Q25, up from 11.6% in FY 2024, 11.0% in 2023, and 10.2% in 2022. The long-term goal is 20% penetration rates.

As detailed in the chart below, loan performance and quality metrics are favorable with FICOs rising again to 744. The 2.1% net credit losses in 1Q25 were down from 2.5% in FY 2024 and 2.3% in 2023 and are comfortably under the allowance for losses of 3.1%, which has remained in a steady narrow range since DFC ramped up after 2021.