Over the past six months, Lithia’s stock price fell to $323.49. Shareholders have lost 6.3% of their capital, which is disappointing considering the S&P 500 has climbed by 8.1%. This may have investors wondering how to approach the situation.

Is there a buying opportunity in Lithia, or does it present a risk to your portfolio? Check out our in-depth research report to see what our analysts have to say, it’s free.

Why Is Lithia Not Exciting?

Despite the more favorable entry price, we're swiping left on Lithia for now. Here are three reasons there are better opportunities than LAD and a stock we'd rather own.

1. Flat Same-Store Sales Indicate Weak Demand

Same-store sales is a key performance indicator used to measure organic growth at brick-and-mortar shops for at least a year.

Lithia’s demand within its existing locations has barely increased over the last two years as its same-store sales were flat.

2. Low Gross Margin Reveals Weak Structural Profitability

We prefer higher gross margins because they not only make it easier to generate more operating profits but also indicate product differentiation, negotiating leverage, and pricing power.

Lithia has bad unit economics for a retailer, signaling it operates in a competitive market and lacks pricing power because its inventory is sold in many places. As you can see below, it averaged a 15.8% gross margin over the last two years. Said differently, Lithia had to pay a chunky $84.24 to its suppliers for every $100 in revenue.

3. High Debt Levels Increase Risk

As long-term investors, the risk we care about most is the permanent loss of capital, which can happen when a company goes bankrupt or raises money from a disadvantaged position. This is separate from short-term stock price volatility, something we are much less bothered by.

Lithia’s $14.3 billion of debt exceeds the $404.4 million of cash on its balance sheet. Furthermore, its 7× net-debt-to-EBITDA ratio (based on its EBITDA of $1.92 billion over the last 12 months) shows the company is overleveraged.

At this level of debt, incremental borrowing becomes increasingly expensive and credit agencies could downgrade the company’s rating if profitability falls. Lithia could also be backed into a corner if the market turns unexpectedly – a situation we seek to avoid as investors in high-quality companies.

We hope Lithia can improve its balance sheet and remain cautious until it increases its profitability or pays down its debt.

Final Judgment

Lithia’s business quality ultimately falls short of our standards. After the recent drawdown, the stock trades at 9.3× forward P/E (or $323.49 per share). While this valuation is optically cheap, the potential downside is big given its shaky fundamentals. We're fairly confident there are better investments elsewhere. Let us point you toward an all-weather company that owns household favorite Taco Bell.

Stocks We Would Buy Instead of Lithia

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