AutoNation, Inc. (NYSE:AN) Q3 2023 Earnings Call Transcript

AutoNation, Inc. (NYSE:AN) Q3 2023 Earnings Call Transcript October 27, 2023

AutoNation, Inc. beats earnings expectations. Reported EPS is $5.54, expectations were $5.42.

Operator: Good morning. My name is Ellen, and I’ll be your conference operator today. At this time, I would like to welcome everyone to the AutoNation Third Quarter 2023 Earnings Conference Call [Operator Instructions]. I would now like to turn the call over to Derek Fiebig, Vice President of Investor Relations. You may begin your conference.

Derek Fiebig: Thank you, Ellen, and good morning, everyone. Welcome to AutoNation’s third quarter 2023 conference call. Leading our call today will be Mike Manley, our Chief Executive Officer; and Tom Szlosek, our Chief Financial Officer. Following their remarks, we will open up the call for questions. Before we begin, I’d like to remind you that certain statements and information on this call, including any statements regarding our anticipated financial results and objectives, constitute forward-looking statements within the meaning of the Federal Private Securities Litigation Reform Act of 1995. Such forward-looking statements involve known and unknown risks that may cause our actual results or performance to differ materially from such forward-looking statements.

Additional discussions of factors that could cause our actual results to differ materially are contained in our press release issued today and in our filings with the SEC. Certain non-GAAP financial measures, as defined in our SEC rules, will be discussed on this call. Reconciliations are provided in our materials and on our Web site located at investor.autonation.com. With that, I’ll turn the call over to Mike.

Mike Manley: Thanks, Derek, and good morning, everyone. Thank you for joining us today. I’m going to start on Slide 3, and I’m going to provide some opening remarks before Tom takes you through the third quarter results in great detail. So as we all know, there continues to be mixed economic signals in the economy. But despite concerns of affordability, consumer demand for vehicles remains relatively healthy. And during the quarter, partly because of improved new vehicle supply and stable used vehicle inventory, we saw double digit year-over-year growth in new vehicle sales and strong sequential growth in used vehicle volume. And frankly, this is the first time in eight consecutive quarters that we’ve seen growth in combined new and used vehicle volumes for automation.

So I think that’s very positive. We also continue to see significant benefits of our clear focus on after sales, which delivered a record quarter for revenue and margin, and as a result, AutoNation delivered a solid performance in this evolving operating environment. So I’m just going to quickly look at the performance by business, and I’ll start with new vehicle sales, where volume was up 12% in total and 9.5% on a same store basis. And as forecasted, new vehicle margin was down sequentially in the quarter but remained above $4,000 a unit. Now during the quarter, we did see some mix impact on our margin and that was driven by significant year-over-year volume growth in our import franchises, which benefited from improved inventory flow, releasing some of the pent-up demand for those brands.

And I’ll touch on the inventory numbers in a minute. But basically, everything that we got, we sold. So we saw quite a large increase in our import dealership volumes in the quarter. But I would say our sales teams tend to look at every potential deal in a very balanced way. And you’ll see our combined margin performance across new and used, which included CFS income held up very well. And in fact, it’s relative to the industry in the quarter and remains well above pre-pandemic levels. I mentioned other inventory levels, so let me touch on that. Obviously, they’ve increased from a year ago, but they remain less than 35 days supply but we have a lot of variation, frankly, among branding categories. We have 51 days of domestic brands. So that probably answers one of the questions about what’s happening in my previous time [indiscernible].

So we have 51 days domestic brands as we said, 33 days of luxury and 17 days of import brands. Now moving on to used vehicles. As you’ll recall, at the beginning of the year, we spent some time talking about the fact that used vehicle inventory would be harder to source and obviously critical to success this year. So knowing that we’ve made continued investments to maintain and grow used vehicle inventory, I think the team in the quarter did a good job sourcing retail quality used vehicles and to facilitate this, we’ve increased our investment and we buy your car marketing and infrastructure, which you’re obviously going to see in our SG&A. In addition, we have our teams looking at every potential sale in a much more holistic way considering not just the vehicle margin but also the income from CFS and additional consideration as the sale yield of retailable trade.

Now as a result, used inventory has been stable, which has helped us post the sequential used vehicle sales increase of over 5%, which would not be possible without the daily focus on vehicle sourcing which, by the way, resulted in over 90% of our total used vehicles being self sourced in the quarter. Now as you know vehicle volume new and used is important for many reasons, but a key one for us is our industry leading performance and customer financial services, which again continued to deliver in the quarter. And then the team has done a great job to overcome a significantly higher interest rate environment and lower finance penetration by continuing to maintain and grow product sales per unit sold. Now moving on to after sales. Here, the business continues to be one of our brightest spots.

Revenue was up 12% and our gross profit was up 14%. The greater complexity of vehicles is leading to higher values per repair order and we’ve also been keenly focused on growing our technician workforce, which is allowing us to serve more customers. I was also pleased with the operating cash generation in our business. It was another great quarter of cash conversion relative to net income, which Tom will no doubt talk more about later. But aside from the solid quarter from a financial perspective, there are a few other highlights I’d like to touch on before handing over. Our 11 million plus customers are our core focus and we’re extending our product offerings and reach into more recurring revenue streams and we’re adding new customers every day across all of our channels.

And during the quarter, we increased the penetration of automation finance at our AN USA stores, where we are now financing roughly one in four AN USA vehicle sales and we have also expanded into our franchise stores. So AutoNation Finance continues to be integrated as a thoughtful and measured place and is, in fact, ahead of where we thought it would be, which is why we expanded it to our franchise businesses. We’re also actively launching supplementary products and services to meet our customers’ needs, which supports consumer vehicle usage and also attracts new customers to us. And we launched a micro lease business called AutoNation Mobility and an e-commerce parts and accessory platform called autonationparts.com. These businesses, along with AutoNation’s recently acquired mobile repair service complements our traditional dealership model while expanding our reach into the transportation industry.

We expanded our AutoNation USA footprint with our 17th store in Hilton Head Island, and this was the fourth opening of the year, and we expect four more openings in the fourth quarter, including our Fort Myers facility, which opened this week. Now as you can imagine, it’s not an easy task to get these greenfield businesses open and up and running. And I’d like to congratulate and thank the teams that continue to work incredibly hard on this. I’m also pleased to say that so far these businesses are selling ahead of plan and are showing considerable growth year-over-year. And by the way, since with this project with AN USA has started they’ve now sold over 70,000 vehicles. So that’s not out for organic growth, I think. So moving on. The exceptional service we provide to our customers did not go unnoticed as AutoNation was recognized as the top public franchise dealer group by reputation of 2023 automotive reputation report, and that’s an honor that we have housed four out of the last five years.

And of course, that is only possible because of the 24,000 dedicated AutoNation associates who work tirelessly in our business and whom I would like to thank. So thank you all for listening, and I thank you in person as I get out into the business model. And finally, we were named best companies to work for list by U.S. News and World. So you can see customers at the central what we do. We are focused on growth, outstanding customer service and operational excellence through our business. And we’re also looking to the future how the industry will evolve and what the needs of our customers will be. There is clearly an opportunity for automation to capitalize on our strong brand and footprint to retain and reactivate customers and provide them with more value and garner a larger share of wallet over a longer period of time.

And now Tom will take you through the financials in greater detail. Tom?

Tom Szlosek: Yes. Thanks, Mike, and good morning, everybody. A more detailed outline of our Q3 highlights is on Slide 4 of the materials. New revenue vehicle was up 11% at $3.2 billion. Volumes in new vehicle were up 12% and including, as Mike mentioned, 25% on imports and 5% on domestic with luxury, roughly flat volume line. Same store volumes were up 9% and revenue per vehicle retail was stable. Used vehicle revenue declined 10% year-over-year with US sales down roughly 4% and revenue per vehicle retail down 6%. Importantly, as Mike mentioned, though, used vehicle sales improved unit wise by over 5% compared with the second quarter. So the efforts of our investments are starting to pay dividends. So Customer Financial Services revenue increased 2% to $370 million.

This reflects the increase in total retail volume from 2022 and fairly stable CFS revenue PVRs. After sales was up 12% to $1.2 billion in revenue, the result of both higher value repair orders as well as improving volumes. After sales gross profit margins were up 14% in the business. Third quarter earnings per share were $5.54, down 8% while operating income was down 16% and interest expense up $44 million, our EPS was favorably impacted by a more than 20% decline in the share count, which obviously is a reflection of our ongoing share repurchase actions. Cash from operations, as Mike mentioned, was very strong through September. It’s up — we were at $763 million, which resulted in conversion on net income of more than 95%. So the company has really impressed me in my first few days — first few months in terms of doing the right things to drive cash generation, including the management of work capital.

Mike also mentioned the integration of AutoNation Finance. This is still a pretty small business for us with roughly a $400 million portfolio but we expect significant growth as we increase the penetration of financing in our stores. As part of these efforts, we’ve discontinued all third party originations and are now exclusively focused on the AutoNation business. In September, AN Finance represented roughly a quarter of the loan originations in AN USA stores, as Mike mentioned. We’ve also commenced lending in our franchise stores. And in for the third quarter, as planned, we sold most of our lower credit tier loans from the legacy CIG portfolio, which generated a pretax gain of $8 million. Turning to Slide 5 for some commentary on our third quarter P&L, on balance, the strength in new vehicle unit volumes and after sales and the stability in customer financial services more than offset the decline we experienced in new vehicle PVRs and used vehicle revenue.

And in this environment, we’re very pleased with the 3% growth in top line from 2022. Gross profit was slightly lower in nominal terms. All in, we were down roughly 90 basis points in gross profit margin to 19%, reflecting the moderation in new vehicle gross profit PVRs but that was largely offset by growth in the aftersales gross profit, as I mentioned. Adjusted SG&A increased 7% to $823 million with generally stable core spending and incremental costs to relate to our growth initiatives, and I’ll touch on that a bit more later. Third quarter floor plan interest expense of $38 million was up from $11 million in the third quarter of 2022, that’s a reflection of both higher rates and borrowings, higher borrowings and it’s about half and half in terms of the impact.

For non-vehicle debt, the interest expense was $49 million, which was up from $34 million a year ago. And again, both higher rates and increased borrowings impacted the interest and expenses as well. Our income tax rate was stable at 25%. So all in, this resulted in $244 million of net income compared to $336 million a year ago. And as I mentioned, our average shares outstanding of $44 million, we’re more than 20% lower than a year ago. This meaningfully blunted the EPS effects of the net income decline as you can see. Starting on Slide 6, I’d like to build on the color Mike gave on the performance in our various revenue categories for the third quarter. As you said, new vehicle volumes were up 12% and this includes over 25% on imports. Revenue PVRs have remained stable for new vehicles.

Gross PVRs continue to moderate, reflecting increased availability of new vehicles and importantly, as Mike mentioned, our intentionality in pursuing higher volumes to drive the other parts of the business. New vehicle inventory levels have increased more than 50% in both units and values from a year ago, and new units have grown from roughly 13,000 units to over 27,000 units. In used vehicles, on Slide 7, we had a modest volume decline of 4% from a year ago with the most pronounced declines from our domestic stores, which decreased 10%, important luxury stores had less pronounced volume decline. As Mike mentioned, we have seen some nice progress since the second quarter with used vehicle volumes up 5% sequentially. And this was more than twice the market’s growth.

There was good traction quarter-over-quarter in the $40,000 and below pricing tiers. Those tiers comprise more than 80% of our unit sales. And even on the higher priced tiers greater than 40,000, which has better profitability, the growth was also respectable at roughly 2%. The demand is clearly there and we’re continuing our initiatives to pursue more supply. Revenue and gross profit [TBRs] and used vehicles were both down year-over-year, mostly reflecting the volume decline and the mix of sales by pricing tier. Used vehicle inventory levels were overall stable at 33 days with growth in lower priced tiers very strong, offset by declines in higher priced tiers. We continue to emphasize health sourcing including trade-ins, lease expiries as well as our [iBuyer] car initiative for the quarter, our self-sourcing represented 96% of used vehicles acquired.

Now moving on to Slide 8. In Customer Financial Services, we delivered 2% revenue increase, roughly in line with vehicle sales unit growth for the quarter. For new vehicles, higher unit volumes and stronger penetration of both finance and nonfinance products are driving stronger CFF. On the used side, a portion of our sales with finance products declined modestly year-over-year given the interest rate environment, but still remains very high at close to 70% penetration. On nonfinancial products, we also had a similar modest decline but still very respectable penetration. On Slide 9, after sales, as I mentioned, up 12% in revenue at $1.2 billion. Customer pay, warranty, internal and collision all experienced double digit growth year-over-year.

So it was very broad across the entire portfolio. The value per order is improving, and the number of repair orders had also increased. And we’re starting to see the benefit from the investment in additional technicians. I think we’ve made over the course of the last few months. Our gross profit grew 14% year-over-year and our gross profit margins were up more than 80 basis points to 47%. And again, this is a reflection of those higher value repair orders as well as the scale benefits we’re starting to benefit from in terms of the increase in the number of orders. A quick comment on the UAW strike. We obviously hope this is resolved in mutually agreeable manner. We’ve been preemptively building inventory where we can and after sales with the support of OEMs. In the third quarter, there was not much of a financial impact apart from the slight inventory build.

We obviously are monitoring the situation closely. Slide 10, Operating income was 6% for the quarter, down from last year, but still much higher than like 200 basis points higher from pre-pandemic levels. The decrease from ‘22 reflects the moderation in new vehicle gross profit per vehicle as well as higher SG&A. And the growth in SG&A reflects investments for growth, including the supporting infrastructure for our AutoNation USA stores as well as for our aftermarket business. We’ve also had some increased advertising spend related to acquisition of vehicles via [Valayar] car initiative. There’s been some inflation and some self-insurance costs for weather related losses. Overall, normalized SG&A as a percent of gross profit, we do expect to remain lower than pre-pandemic levels.

Slide 11. Our operating cash flow generation remains very robust. We were at 105% conversion of net income for the quarter. Our cash flow from operations was $256 million in the third quarter and we increased our non-trade floor plan by $89 million and our CapEx was $87 million. So together, these have resulted in free cash flow of $258 million for the third quarter. CapEx for the quarter was up around 10%, reflecting a steadily increasing reinvestment ratio, where we’re now at roughly 1.6 times depreciation. And the principal year-over-year increase in CapEx that drove that 10% has mostly been for growth, including the AN USA expansion, some facility spending for electric vehicles and some IT related projects. Slide 12 shows our capital allocation for the first nine months of 2022 and 2023.

Last year, our capital allocation focus was on reinvesting in the business and share repurchases. Since the beginning of 2022, in fact, we’ve repurchased roughly 21 million shares, which is more than third of our outstanding share count. It was a low interest rate environment. We are enjoying recovery driven cash flows. The M&A landscape wasn’t presenting deals we viewed as attractive and we had a dislocation in our share price. And while we still believe in the longer term value that would be great in our share price, over the course of ’23 as interest rates have increased and our cash flows have normalized, we’ve moderated the level of share repurchase activity still. When you look at it as a percentage of free cash flow, the share repurchases are relatively stable, close to 100% of free cash flow.

At quarter end, our leverage was 2 times EBITDA. This is at the low end of our 2 to 3 times target. Michael and I very comfortable with where we sit there. And moving forward, we’ll continue to allocate capital to maximize shareholder value. So with that, I’m going to turn it over to Mike to wrap things up.

Mike Manley: Yes. Thanks, Tom. I’m just going to, again, before we go to the Q&A session, thank all of our associates in the business. And as I said, I think that there’s been a lot of progress in terms of putting infrastructure in place, building new offerings, products and services for our customers as well, and that will take tremendous effort. So thank you all. And with that, let’s start the Q&A.

Derek Fiebig: Ellen, if you could please prompt the audience how to get in the queue.

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Q&A Session

Operator: [Operator Instructions] We’ll take our first question today from John Murphy from Bank of America.

Mike Manley: Maybe we have to come back to John.

Operator: Okay. Let’s move on to Rajat Gupta from JPMorgan.

Rajat Gupta: Just had a question first on parts and services. Clearly, very strong trends there. I think it was the best result amongst your peer growth. Would you be able to give us any more color there in terms of any differences you saw across the regions that might have led to the growth, as well as if you could quantify how much of it might have been driven by either the traffic or pricing or mix, any way to size that growth and expectations going forward as well? And I have one quick follow-up.

Mike Manley: The growth came from both an increase in volume. We saw as we progressed through the quarter, volume increasing as a result of the increase we had in terms of productive technicians. So a combination of that and reaching out into the vehicle park grew [RR] account. But then we saw value growth really across our customer pay, our internal work as well with the growth that we saw in new vehicles and the sequential growth of used and then warranty was up as well. So it’s a combination of both of those things. I have not seen a big difference in terms of the geographical distribution of that growth. If I look broadly across the market, it’s roughly in line. So I don’t think that there’s necessarily anything from a geography perspective that’s influenced it. So in summary, just a combination of increased volume but increased value per [RR] as well.

Rajat Gupta: And then just on new cars, helpful color on the slides on how you’re strategizing the overall profitability there. You mentioned in your prepared remarks that you were selling like all of inventory that was coming in. But the slide deck — but you also suggested that you were trying to push volume in order to monetize CFS and [parking] services. I just wanted to make sure I’m understanding both those comments correctly. Did you have to stimulate volumes with some GPU reductions in order to make sure you still get the F&I or CFS income, or if you could just clarify that a bit would be helpful?

Mike Manley: No problem. And by the way, if — I will try and clarify but feel free to dive in and redirect. What we ask the teams to do, we’ve obviously invested a lot. We recognized — so let me just step back. As I mentioned in my opening comments, we recognized that how we manage our used vehicle inventory as we go through this year and get into next year is going to be critical for us to be able to continue to progress not just in terms of used vehicle sales for our franchise businesses, but also be able to stock up all of the incremental AN USA stores that we’re opening. And we recognize — we’re investing a lot of money in that, whether it’s incremental marketing or incremental infrastructure to support how we buy your car.

And what we ask our teams to do is to take a very holistic view in terms of volume in the marketplace, not to distress sell anything at all but just to recognize that we have a very good record in terms of CFS performance, we have a very good record in terms of sales sourcing. And as you’re looking at opportunities in the marketplace, just make sure you’re taking all of those into account, because one of the most profitable sources for used vehicles, as you know, is actually the traders that come on a new or used car sale. So it was really a reflection of us making sure that people are recognizing that there are multiple different sources of profit in an individual sales deal and just make sure you’re reflecting that as general managers, as general sales managers, in the dealerships when you’re building a month.