AutoNation, Inc. (NYSE:AN) Q4 2023 Earnings Call Transcript

AutoNation, Inc. (NYSE:AN) Q4 2023 Earnings Call Transcript February 13, 2024

AutoNation, Inc. beats earnings expectations. Reported EPS is $5.02, expectations were $4.85. AutoNation, Inc. isn’t one of the 30 most popular stocks among hedge funds at the end of the third quarter (see the details here).

Operator: Hello everyone, and welcome to the AutoNation Incorporation Fourth Quarter 2023 Earnings Conference Call. My name is Bruno, I’ll be operating your call today. [Operator Instructions] I’ll now hand over to your host, Derek Fiebig, Vice President of Investor Relations. Please go ahead.

Derek Fiebig: Thank you, Bruno, and good morning, everyone. And welcome to AutoNation’s fourth 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’ll 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 under SEC rules will be discussed on this call. Reconciliations are provided in our materials and on our website at investors.autonation.com. With that I’ll turn the call over to Mike.

Michael Manley: Yes, thanks Derek, and good morning, everybody. Thank you for joining us today. I’m on Slide 3 and I’m going to provide some opening remarks before I hand over to Tom, who is going to take you through our fourth quarter results in greater detail. Now, as we know, there continues to be mixed economic signals in the economy, and concerns over affordability. But from our perspective, consumer demand for new vehicles remains robust. During the quarter, our total new vehicle revenue increased 7%, and unit sales increased 5%. And this reflected strong import growth, as well as the seasonal uplift in Premium Luxury sales. New vehicle margins continue to decline, but the rate of moderation in the fourth-quarter, which is approximately $120 per month was more modest than earlier quarters.

Total new vehicle inventory levels of 76 days increased from 19 last year and 31 in the third quarter. We have 66 days of domestic brands, 29 days of luxury and 24 days of import brands. Inventory levels are expected to continue to grow in 2024, and as such, we expect to see a continued moderation of new vehicle margin, which we anticipate will be roughly the same pace as we experienced in Q4. Turning to used vehicles, same-store units decreased 8% a year ago, while total units were down 4%, which reflects the growth of AN USA stores in the year. The more recent sequential comparisons have a slightly better than the market. Now, we’re managing several critical variables in the used market at the moment. Firstly, we continue to see tight availability and this has been with us throughout 2023 and will no doubt continue into 2024.

And notwithstanding the inventory availability was seeing used vehicle depreciation, which is broadly back to normal than historical levels. Mix between price is also normalizing, and as a result, we are seeing lower demand and higher price used vehicles, partly because of affordability and partly because new vehicles are becoming more available with lower net transaction price, which is often accompanied by subsidized lending rates, which makes new product more compelling for a number of our customers. Tom is going to give you some of the specifics on unit sales by pricing band. Our inventory turns on used vehicle declined modestly during the quarter. The mix change I just noted, combined with slower turns moderated our used PVR. And we expect these market conditions to continue into 2024, and as a result, we expect our Q1 2024 used margins to be in the same range as our Q4 results.

Now, we’ve maintained our industry-leading performance in customer financial services in the quarter. As the team continued to do an outstanding job to overcome a higher interest rate environment, by maintaining solid growth in product sales per unit sold compared to year ago. This performance combined with a 2% increase in total retail units sold resulted in higher CFS gross profit. After sales delivered a record fourth quarter for revenue and margin. Total store revenue was up 11%, and our gross profit was up 13%. Growth came from all major categories. The greater complexity of vehicles is leading to higher values per repair order. And this coupled with increased numbers of repair orders from a year ago, resulted in what I think is an excellent performance.

The strength of our balance sheet and cash generation, which Tom will discuss, allowed us to deploy an additional $150 million towards share repurchases during the quarter, repurchasing more than 1.1 million shares. Now, aside from the solid quarter from a financial perspective, there were few other highlights I’d like to touch on. We continue to focus on our customers and are working to garner greater share of customers’ wallets. As such, during the quarter, we continued integrating AutoNation Finance across our portfolio, including the launch into nearly all of our franchise stores. We also continued with the rollout of our AN USA stores, opening locations in Plano, Texas and Fort Myers, Florida during the quarter. And we opened additional stores in Florida early this year with Wesley Chapel, Sanford and Jacksonville, adding to density in these markets.

I think our business model is resilient, working well and we continue to deliver strong financial performance. Now, this performance has of course made possible by our 24,000 plus AutoNation associates who take care of our customers every day. And I think the team efforts continue to be recognized by outside parties because of this. And this year AutoNation once again made Fortune’s Most Admired list, jumping four spots to number three in the Specialty Retailer Section. Congratulations to everybody. Thank you for the things that you do for us. And with that, Tom, I’m going to hand over to you. Thank you.

Thomas Szlosek: Okay, perfect. Thanks, Mike. I’m turning to Slide 4, to comment on our fourth quarter P&L. Total revenue increased slightly, as growth in new vehicle and after-sales revenue more than offset lower used vehicle revenue. As expected, gross profit was down 5% and margin was 18% for the quarter. As strong growth in after sales partially offset declines for new and used vehicles, which I’ll address in later slide. Adjusted SG&A increased 5% to $791 million, with stable core spending and incremental costs, related to our growth initiatives. This resulted in adjusted operating income of $368 million for the quarter, which decreased 22% from a year ago. Below the operating line, our fourth quarter results were impacted by higher interest expense, for both floorplan and non-vehicle debt, and benefited from lower income tax expense.

The fourth quarter floorplan interest expense of $47 million was up from $20 million a year ago, a reflection of higher rate, and inventory level as expected. As a reminder, we reflect floorplan assistance received from OEMs in gross margin. And in the fourth quarter, the increased assistance helped to offset partially, the increase in floorplan interest expense. Interest expense for non-vehicle debt was $46 million for the quarter, up from $38 million a year ago. The increase reflects increased borrowing and higher rates. Income tax expense for the quarter was $62 million compared to $91 million in 2022, reflecting. lower taxable income and a modestly lower income tax rate. All in this resulted in adjusted net income of $216 million compared to adjusted net income of $319 million a year ago.

The impact of our share repurchase activity partially offset the EPS effect of the lower net income. Total shares repurchased over the year decreased our average shares outstanding by 14% to 42.9 million shares in the fourth quarter, our adjusted EPS was $5.02 for the quarter. Starting with Slide 5, I’d like to build on the color Mike gave on the performance in our various revenue categories for the quarter. New vehicle volumes were up 8%, which includes increases of 16% on imports, 3% on Premium Luxury and flat domestic units. New vehicle gross profit PVRs continue to moderate. While selling prices were stable, vehicle costs were higher. The rate of decline for the fourth quarter and gross profit PVRs was about $335 per unit, which slowed from approximately $600 per unit sequential decline in recent quarters.

This reflected the higher seasonal premium luxury mix and a more stable, although still less than ideal environment for battery electric vehicles. New vehicle inventory levels, including vehicles in transit have increased from 18,100 units in 2022 to 35,300 units at the end of 2023. Moving on to Slide 6. In used vehicles, we had a unit volume decline of 4% from a year ago, as Mike mentioned on a total store basis and 8% on a same-store basis. There continues to be a shift to lower priced used vehicles. Our same-store unit sales of used vehicles priced under $20,000 increased 7%. While used vehicles over $40,000 increased 20%, and used vehicles priced from $20,000 to $40,000 were down 11%. From a segment standpoint used unit volume performance was strongest in our import brands.

Year-over-year unit sales and gross profit PVRs in used vehicles were adversely impacted by the pricing dynamics I mentioned and reflects an overall softer used-car pricing environment. Used vehicle inventory levels increased sequentially and year-over-year, reflecting our stepped-up buying activity, in anticipation of the customary spike in the first quarter used car volume. As Mike mentioned, we expect our first quarter PVRs to be at or slightly below fourth quarter levels, reflecting a conscious effort to align inventory levels and churn rate with the market. Used PVR improvement is expected late in the first quarter as the fourth quarter inventory is fully churned. Used vehicle sales and profitability continue to be a big area of focus for us as we emphasize effective sourcing, pricing and speed, while optimizing customer satisfaction.

I’m now on Slide 7 in customer financial services, our industry-leading performance continued. As you can see gross profit PVRs for CFS remained strong and would have been even stronger after the shifting of economics related to AutoNation’s finance lending. The upfront fees previously received from non-recourse third-party lenders is now deferred over the life of the AutoNation Finance loan. New vehicle product attachment and finance penetration in CFS remains strong and increased from a year ago. We have seen an increase in leasing, which represents 23% of new sales in the fourth quarter compared to 13% last year. This is a minor headwind for CFS, PVR, at least vehicles historically had a lower CFS attachment rate. Unused vehicles, there were slight decreases from a year ago on both the and product side of CFS, as higher interest rates consumed more of our customers’ monthly payment capacity.

As Mike mentioned an ambition to fully supporting all AN USA stores, we now have AutoNation Finance present in nearly all franchise stores. In the fourth quarter, we originated approximately $110 million in loans, up from $63 million in the third quarter. The AutoNation Finance business continues to improve in all dimensions, including penetration in our stores, profitability and delinquency rate. Let’s move to Slide 8. After-sales represents about 44% of our gross — our total gross profit in the quarter, and continue to grow with total store revenue increasing 11% to $1.1 billion or 9% on a same-store basis. Customer pay, warranty and internal all experienced double-digit year-over-year growth. The value per order is improving, and our total number of repair orders have also increased.

Gross profit grew 13% year-over-year on a total store basis and 12% on a same-store basis. Total gross profit was up double digits for customer pay, warranty and internal. And our gross profit margins were up more than 70 basis points to 47%, reflecting higher repair orders, our value repair orders and scale benefits from the increase in the number of repair orders. For the full year, our after-sales gross profit was more than $2.1 billion, which is up more than $500 million from 2019. This high margin business is a key part of our continued engagement with our customers, and we’re focused on capacity utilization, technician development, to support the continued growth of the business. Importantly, our total technician workforce increased 6% from a year ago on a same-store basis and 11% in total.

Moving to Slide 9 our adjusted operating income was 5.4% for the quarter, down from last year, but up more than 150 basis points from pre-pandemic levels. The decrease from 2022 mostly reflects the moderation in new vehicle unit profitability, which was expected and is consistent with the industry, as well as higher SG&A. The growth in SG&A reflects investments for growth, increased advertising spend and inflation. Normalized SG&A as a percentage of gross profit is expected to remain lower than pre-pandemic levels. During the fourth quarter, we recognized about $7 million of severance expenses as we streamlined our regional field team, and rationalized some support functions. On Slide 10, you can see our adjusted free cash flow for the year was $969 million compared to $1.5 billion a year ago.

The change year-over-year is consistent with our change in EBITDA. A reconciliation for adjusted free cash flow is included in the appendix of this presentation. Year-over-year, our total inventory increased by approximately $1 billion, which was largely funded by higher trade floorplan financing and nontrade floorplan financing, which increased $424 million from a year ago. While we expect a continued normalization of new inventory levels, we are focused on the velocity with which we turn our overall vehicle inventory. Consistent with the expansion of AutoNation Finance, our net auto loans receivable increased by $230 million, and we expect continued growth in this portfolio. CapEx for the full year was $410 million compared to $329 million a year ago, reflecting primarily capacity growth at franchise stores, IT spending and facility electrification infrastructure.

This resulted in an adjusted free cash flow of $969 million and a strong conversion of 94% of our adjusted net income. Slide 11 shows our capital allocation for the years 2022 and 2023. In 2023 we had a balanced mix of reinvestments and return to shareholders. CapEx of $410 million was about $80 million higher than 2022, as I mentioned. M&A investments, which occurred earlier in the year totaled $271 million. With significant cash flow generation and strong balance sheet, we returned $864 million to shareholders via share repurchases, reducing our shares outstanding by 13%. We have an additional $320 million remaining under our current board authorization for share repurchases. At quarter end, our leverage was 2.19 times EBITDA, the lower end of our 2 times to 3 times target, and we continue to maintain our investment grade credit rating.

Moving forward, we’ll continue to allocate capital to maximize shareholder value, considering both near term market conditions, the M&A landscape, particularly for core franchise operation and the longer term direction of the industry. Now I’ll turn the call back over to Mike to provide some commentary regarding 2024.

Michael Manley: Yes, thanks Tom. Yes, we thought it would be helpful just to provide some thoughts regarding 2024 and how we see things may be progressing. On the new side of the business, as we know vehicle supply is going to continue to return to pre-pandemic levels. And I think leasing and retail incentives are clearly going to pick up through the year but I think will remain below pre-pandemic levels in total. So inventory levels will continue to increase over the course of 2024, but we expect demand to be robust. Battery electric vehicle product introduction and customer interest in these vehicles is clearly going to be a key dynamic this year. As widely reported, bad PVRs consistently fell during 2023 and in most instances, are lower than similar combustion engine vehicles.

And as with all things, it’s about balance and it does appear OEMs are adjusting their plans and actions to match demand more closely. And frankly, this will be well received. Hybrid are doing well in the marketplace, and we have good exposure to this portion of the market based upon our brand mix, and we expect our new margins to continue to moderate over the course of 2024, but at a somewhat slower pace than we experienced in 2023. Used vehicle market will likely remain constrained, as late model used vehicle availability remains limited and additional new vehicles are available. The key is going to be our effectiveness as always in purchasing pricing and turning our inventory, and we’re going to remain nimble in our approach to those things in the market as it develops.

I expect our CFS to continue to perform well even with pressures coming from overall monthly payments, vehicle mix and OEM actions to support unit sales. And as you’ve seen, it’s a very consistent and clear strength of our organization. After-sales has been and will remain a significant area of focus for us. You saw the results in our Q4 outcome and after strong growth in 2023, obviously. Our year-over-year comps will moderate, but we expect this area of our business to continue to grow attractively. And we will, as always, be focused on managing the controllable variables, which includes cash flow and capital deployment. And with that, Tom, let’s hand it over to Derek to get some questions.

Derek Fiebig: Yes. Bruno, if you could please remind the audience how to get in queue for question-and-answer please?

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Q&A Session

Operator: Sure. [Operator Instructions] We do have our first question registered, comes from John Murphy from Bank of America. John, your line is now open.

John Murphy: Good morning, guys. Just wanted to ask the first question, Mike, on after-sales. I mean it’s obviously a bright spot. It seems like the efforts there to do higher techs is really paying off. You keep talking about share of wallet increasing. It seems like the area where your share of wallet for consumers is — there’s obviously the most opportunity other than getting to the second and third turn of the used vehicle. So as you think about this in 2024, maybe even just beyond in sort of a strategic standpoint, what do you think you need to do to continue to drive that significantly higher? Is it just a function of hiring more techs? Is it an increase in connectivity? Is it getting involved in the second and third used vehicle turn? What’s the key strategy there? And what are the opportunities to drive that faster or farther?

Michael Manley: So John, it’s probably a combination of all of the above. If I think about our franchise business firstly, we have a penetration in the vehicle parks that were responsible for our areas of operation that are franchises represent probably around 50% plus minus. And what we know is that customers move on to other sources for that service, when the vehicles get seven years old or they’re 25 miles beyond the radius. So there’s a lot of opportunity within the territories that we have. And then we’re providing channels and access to our customers who would have migrated to a different source for their servicing and repairs through things, such as our mobile service, which, as you know, is a new addition to us. So I think partly in terms of our installed assets, we have sufficient bay capacity.

We saw — from my memory I think it was a 5% or 6% increase in our technicians during the period. There is opportunity for us to continue to grow that, adding services onto it, and then we’ll backfill with mobile services for those customers that don’t, for whatever reason moved away from the franchise environment. So that’s going to be a big focus for us this year. There’s plenty of opportunity. It’s not easy to unlock, because once a customer is migrated, they obviously form a relationship, and that leads me to the last thing, and that is we have a fantastic brand. I think last time we checked our brand, which we do relatively regularly. It was the most known automotive brand in the United States. And I think we can do a better job of communicating all of the products and services to our customers, to help them understand that we can increasingly look after a broader set of needs that they have, not just for themselves, but also in their family.

John Murphy: Okay. That’s helpful. And then just a second question on the used-car business, obviously, GPUs are down. It sounds like there is a little bit of mix going on, also sort of a little bit of inventory management. Is this the kind of thing that you think is really a function of the next couple of quarters and then you get back to normal GPUs or is there something happening here sort of cyclically or secular basis that we keep these numbers low?

Michael Manley: No, absolutely. As Tom mentioned, I think one of the things that, as we came into 2023, our inventory levels were very low, and we felt that we missed out on some of the marketplace. We put in place a number of initiatives middle of last year through the end of last year to enable us to source the vehicles that we need, and we did that very, very effectively. At the same time, I think some of the market dynamics were changing. One of the things that had increased dramatically during the COVID period was the percentage mix of vehicles above say, $35,000 and Tom gave you the mix. And we’re seeing those customers who maybe came into the high end of the used car market because they couldn’t get new, now returning back to the new car market with lower transaction prices and more incentives to manufacturers.

And what we need to be is very, very agile to make sure that as the market changes, and I think it will continue to change, that we are ahead of those mix changes. And we have some work to do. We did — we started that work in — before the end of last year, continued through January. I think that work will be largely completed by the end of Q1, very early Q2. So in my mind, it’s transitory. The good news is that each one of those unit sales comes with phenomenal CFS performance and obviously is going straight into our after-sales database for us to be able to look after them. So every customer comes now with — from our perspective, with a great opportunity not just with a sale.

John Murphy: So, Mike, when you get the turn and earn back being efficient, would it be fair to say that, that $1,800 range on PVR is something that we should think about sort of mid-to-long term as we get through the course of this year and beyond?

Michael Manley: Yes, I think that’s a very — I think that’s an achievable number for sure, yes.

John Murphy: Great. All right. Thank you very much.

Michael Manley: Thanks, John.

Operator: Our next question comes from Daniel Imbro from Stephens, Inc. Daniel, you may proceed with your question.

Daniel Imbro: Yes, hey good morning, everybody. Thanks for taking my questions. Mike, I wanted to start maybe on the new GPU side. Obviously, a little bit lighter moderation, your commentary suggested that’s going to continue in 2024. Curious if you can say about how the OEM conversations are going? Are you seeing any change in tone, especially at some of the brands where inventory maybe has built. And then I’m curious, given your experience on the OEM side, what levers do you think pulled? Do you see them cut MSRP? Kind of how do you think they navigate through some of the heavier inventory situations out there?

Michael Manley: Yes, thanks, Daniel. Well, even though — and I mentioned this in my opening commentary, until the time we’re seeing some increases in terms of retail incentive rates and leasing back up to 23%. We’re still not at the levels that we had seen before. And I think as we begin to see inventory build, we will see continued action in that area from the OEMs leasing in my view by the end of this year, early next year, we’ll be back to pre-pandemic levels. And I think we’ve seen much more subsidized finance with obviously with the interest rates that we have and that will continue as we get deep into 2024. When I think about overall days of supply obviously, it’s very different depending on the manufacturers and the brand partners that we have, but clearly still well below in many instances, the level we saw.

And from my point-of-view, as the industry develops this year, I think we will truly see hopefully, how the manufacturers are thinking about the balance of their inventory, and prevailing market conditions because we talked a lot about this when we were deep in the pandemic. I think this year we’re going to see how each OEM is going to address that and some will be more disciplined, some will be less.

Daniel Imbro: Got it. That’s helpful and then maybe Tom on the finance side, I think Mike and you both mentioned, you’ve rolled out AutoNation Finance into all the franchise stores. Curious if you could maybe provide some stats around the loan growth in the quarter maybe Q4 reserves, you’re taking your provision for losses. And then how those loans are performing, as we think about the changing consumer credit backdrop today?

Thomas Szlosek: Thanks for the question, Daniel. As everybody knows we bought AutoNation Finance in October 2022 we closed. It started out entirely as a third-party lender mostly to subprime. We’ve over the course of the last year completely converted that to now supporting AutoNation exclusively, both AN USA stores as well as the franchise stores. Very little in terms of subprime. So it’s really gone through a nice transition, we love the platform, we love the team. The trends have been very, very strong. We’ve got as I said improvement in the origin mix with all AutoNation customers, FICO scores have improved between 50 and 100 basis-points in terms of what we’re originating. On the credit quality trends 30-day delinquencies have been really strong.

I mean in the third quarter, we were probably 7.5% delinquent. That’s improved by about 200 basis points through the end of January. So team is doing a nice job in what is not an easy environment for consumer credit. So we’re happy with that. The penetration rates amongst our stores where we’re present has been growing, has been very strong. So it’s about $450 million portfolio, and that is after a sale of chunk of the business in the third quarter, which was — it’s about $80 million. We’re excited about 2024. We think the originations could double and we just couldn’t be more pleased with how the business has developed over time.

Daniel Imbro: Appreciate that. Just a quick accounting follow-up. Where do those CECL reserves, as the loan balance — you said they’re going to double the loan growth. I guess where does that flow through the income statement as we think about modeling out the growth in the finance business?

Thomas Szlosek: It’s all in that one line other income and expense on P&L. While growing like I said, it’s probably not material enough for us to break that out. I think at some point we’ll address that depending on how the growth is, but it’s all basically collapsed in that one line.

Daniel Imbro: Great. Thank you so much, guys. Best of luck.

Operator: Our next question comes from Rajat Gupta from JP Morgan. Rajat, your line is now open.

Rajat Gupta: Great, thanks for taking the question. Thanks for all the color on 2024 expectations around the new business, the used as well. But curious, is there a range you’re targeting for SG&A to gross for the year in context of the study, new GPA decline, some of the pressures in the U.S. business, how should we think about SG&A to gross for 2024. I have a quick follow-up. Thanks.

Michael Manley: Yes, Rajat. The way that we’re thinking about this is, obviously in what I would call our core businesses. The things that we’ve put in place over the last few years continues to have I think clear benefits. Our SG&A also includes some of the investments that we’ve been making progressively in the last two years. So the percentage that we see doesn’t represent the core businesses in sales. But I think the range that we sit in now is the range that we’re going to continue to target going forward. And it will fluctuate, as I said, based upon the additional investments that we are making, for example, in mobile services, for example, in our parts commerce business as we grow those businesses. So that’s kind of my view on SG&A at this time.