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On 1/8 we observed that KAR shares had gotten too cheap as the market was valuing core ADESA at only 3x ‘19 EBITDA (and all of Remain Co. at 5.5x EBITDA) and the prospects of the forthcoming spin were being ignored. Even if Remain Co. post-spin stays at the current 7x we think there is a strong chance that it becomes an LBO candidate fetching at least 9x ‘20 EBITDA, which should effectively put a floor on KAR valuation.

Once a quarter, we comb through corporate filings and summarize the most noteworthy datapoints.  At a high level, developments during the quarter reinforced our view that investors should be Underweight Autos and Auto Parts, Underweight Dealers, and Overweight a relatively small selection of companies that fall into the Auto 2.0 category.  In our view the U.S. Auto Cycle is in its 8th or 9th inning, with looming pressures on vehicle affordability.  China is experiencing its first real Auto Industry downturn, and we are not convinced that the Central Government will step in to specifically prop up Autos.   Europe also faces a number of challenges:  These include potential trade risks (7% of Europe produced vehicles are exported to the U.S.), political risks (Brexit), and regulatory risks (vehicles more expensive to produce, at the same time that pricing has become more challenged). 

KAR reported Q3 2018 results post-close (11/6/18). Total revenue of $934m exceeded cons. of $910m but was below our $940m. Adj. EBITDA of $216m missed cons. $223m and our $228m. KAR EBITDA missed on both ADESA and IAA but met on AFC. Adj. EPS of $0.70 was in-line with cons. of $0.70 and below our $0.76.

We are increasing estimates and rolling our SOTP derived price target to a year-end 2019 value of $72 offering 20% upside plus a 3% dividend yield. Our price target uses a SOTP derived 11.3x EV/EBITDA multiple on 2020E including 9.5x ADESA, 10.0x AFC (13.9x P/E), and 13.5x for IAA (for comparison CPRT is at 16.0x).